China's government is struggling to control its financial sector as an economic growth spurt raises concern about off-book bank loans.
Last month, official media initially cheered after the government announced better-than-expected economic figures showing that first-quarter gross domestic product rose 6.9 percent from a year before.
The National Bureau of Statistics (NBS) quarterly estimate easily topped the government's target of "about 6.5 percent" for all of 2017.
"Amid a rising tide of protectionism and increasing policy uncertainties, China's economy remains resilient, which has contributed a lot to global growth," the official Xinhua news agency said as the International Monetary Fund (IMF) raised its 2017 growth forecast from 6.5 to 6.6 percent.
The government credited a 7.7-percent increase in the tertiary or service sector, accounting for 56.5 percent of the quarter's GDP. But foreign reports focused on recovery of the secondary sector or manufacturing, which rose 6.4 percent with record monthly steel output in March.
"Once again, China's policymakers leaned on infrastructure and real estate investment to drive expansion," Reuters said.
The initial optimism over the GDP performance soon gave way to concerns over how it was achieved.
Too much credit, too much debt, too much risk, officials said.
"Accurate judgment of potential financial risks serves as a precondition for maintaining financial security," President Xi Jinping warned at a meeting of the Communist Party of China (CPC) Central Committee on April 25.
"The country must strengthen risk prevention ... to avoid neglecting any risk or hidden trouble," Xinhua cited Xi as saying.
On May 1, a senior official of the People's Bank of China (PBOC) voiced greater concern over credit emissions.
"China's overall leverage level is reasonable but is rising at an alarming pace, especially in the financial sector," wrote Xu Zhong, head of the PBOC's research bureau, in the weekly Caijing Magazine.
Behind the country's high GDP numbers are troubling forces in financing and the murky world of unregulated or "shadow" banking that may be beyond the government's control.
‘Harshest crackdown in history’
Economic worries continued Monday as the government released disappointing trade figures for April.
Imports rose 11.9 percent and exports gained 8.0 percent in dollar terms, falling short of growth in March and analysts' expectations, Reuters said.
But warnings over heavy leveraging in the economy remain the overriding concern.
In a commentary last week, Xinhua said regulatory agencies would target shadow banking and "other undesirable practices," citing calls for "the harshest crackdown on financial risks in history."
Real estate investment and construction, which drive production in steel and building materials, have spurred credit schemes that elude regulation.
The combination of stimulus spending, unregulated lending and property speculation helped push the quarterly GDP over the target mark.
The PBOC belatedly tried to reduce lending in January to restrain the building boom and related industries, but a Bloomberg News report on financing suggests that the effort failed.
"Since late last year, the PBOC and regulators have taken steps to rein in risks to China's financial system, including raising short-term interest rates, clamping down on leverage in the bond market, and curbing funding for property speculation," Bloomberg reported on April 18.
"The measures have sent debt-reliant borrowers scurrying to shadow financing," the report said, referring to unregulated loans made largely by affiliated operations of regulated banks.
Moody's Investors Service has valued the shadow finance sector at U.S. $8.5 trillion (58.5 trillion yuan).
A sudden 754-billion yuan (U.S. $109-billion) surge in shadow lending took place in March when the PBOC tried to cut back on traditional bank loans and bond financing in an effort to cool speculation in the overheated property market.
Despite a wave of local measures aimed at barring investment in multiple dwellings, banks responded with alternate financing and shadow bank loans to fund eager buyers.
After a spike in January, the PBOC clamped down on home mortgages and traditional bank lending, only to see a jump in shadow financing schemes.
Official bank loans during the quarter fell 8.5 percent from a year earlier to 4.22 trillion yuan (U.S. $612.8 billion). But aggregate financing, which includes shadow lending, set a record at 6.93 trillion yuan (U.S. $1.0 trillion), pumping up the property bubble.
In March, loans to households jumped to 797.7 billion yuan (U.S. $115.8 billion), accounting for 78 percent of all new loans for the month.
The short-term lending apparently took the place of mortgages to finance property purchases, said Wendy Chen, a Nomura Securities economist in Shanghai, according to Reuters.
Property demands unleashed
The shadow financing surge highlights the demand for property that previous government policies unleashed.
After a downturn in property prices in 2014, regulators encouraged developers and buyers with easy bank loans to fuel economic growth. The real estate market has now proved hard to turn off.
While the NBS cited signs of slower price growth for new homes in March, many cities have still reported year-on-year gains of more than 20 percent.
Fears of credit tightening have threatened to spread into China's stock markets. The Shanghai Composite Index suffered its biggest drop of the year on April 24 with a 1.37-percent decline due to credit concerns.
The sudden slide in the market may have been the reason behind Xi's chilling statement on risks to the Central Committee the next day.
The group study meeting attended by Politburo members followed a series of warnings over credit and debt.
At a press conference after its spring meeting in Washington on April 21, the IMF indicated that it expects credit tightening will slow China's economic growth pace this year.
"We also see some new focus of policies on reining in financial stability risks, in the shadow banking particularly, and as these measures take hold we do expect some slowdown of the very strong momentum going into the second half," said Markus Rodlauer, deputy director of the IMF's Asia and Pacific Department.
Official media reports have recognized the risk that the country faces from either excessive credit or abrupt tightening.
"China is walking a tightrope between deleveraging and maintaining growth," said a Xinhua analysis on April 25.
"The IMF has warned of breakneck expansion in bank lending and dangerous real estate bubbles. Effective measures are essential to resolve these problems to prevent them from growing too costly to solve," said another Xinhua report.
Enhancing risk controls
In the wake of the first-quarter results, the PBOC and the China Banking Regulatory Commission (CBRC) have promised new steps to enhance risk controls.
Banks have been pressured to stop making shadow loans backed by high-interest offerings known as wealth management products (WMPs).
Last week, the China Securities Regulatory Commission (CSRC) also vowed that "no hidden risks will be neglected" in the effort to keep the financial sector under control.
Dwight Perkins, a China expert and Harvard University professor emeritus of political economy, said he expects the PBOC to move carefully on shadow banking.
"I think there is a broad view that they should be a bit more effective in regulating shadow banking, but shadow banking by itself is not a bad thing," Perkins said in a phone interview.
Originally designed to circumvent strict interest rate controls, which have since eased, shadow financing still allows lenders to avoid administrative restrictions, Perkins said.
"Some of it is problematic. When financial people give them too much free rein, there's going to be a subset of them that take high risks and may increase non-performing loans," he said. But much of the financing comes from regulated banks, in any case.
Sudden or sweeping new restrictions on the shadow sector could expose the economy to higher risks than allowing it to continue.
"Some big, abrupt administrative action certainly could be disruptive," said Perkins. "If they just set out to prohibit any further lending of a certain type, that might create problems."
Other analysts have speculated that the high GDP growth rate of the first quarter will give the government room to rein in credit and excessive industrial production more effectively for the rest of the year without worrying whether its 6.5-percent GDP target will be met.
On the other hand, pro-growth forces may push for higher GDP numbers to make a show of success for the leadership in time for the 19th National Congress of the CPC in the fall.
Some economists have argued that the government should scrap the GDP goal-setting exercise altogether as a vestige of the central-planning past.
"They've got to get away from this GDP target, but nothing's going to happen until after this party congress," Perkins said.