Chinese economy hit by bad loans, may further slow down

China's new bank loans rebounded in March, rising far more than expected, as policymakers pushed lenders to support struggling smaller companies and shore up the slowing economy. Analysts say China needs to turn around weak credit growth to head off a sharper economic slowdown, but there are concerns that may fuel a further rise in bad loans as banks loosen lending standards.

Chinese banks extended 1.69 trillion yuan ($251.59 billion) in net new yuan loans in March, compared with analysts' expectations of 1.2 trillion yuan in a Reuters poll. New lending had pulled back in February due to seasonal factors after a record credit pulse in January. "The latest data suggest that credit growth may now be bottoming out due to the PBOC's efforts to loosen monetary conditions. However, a rapid economic turnaround is unlikely," Capital Economics said in a report.

Total bank lending in the first three months of 2019 hit a record quarterly tally of 5.81 trillion yuan. Broad M2 money supply in March grew 8.6 percent on-year - the highest in 13 months, data released by the People's Bank of China showed on Friday, also well above estimates. Analysts had expected a rise to 8.2 percent, from 8.0 percent in February.

Outstanding yuan loans grew 13.7 percent from a year earlier - the fastest pace in nearly 3 years. Analysts had expected it to hold steady from February at 13.4 percent. The growth of outstanding total social financing (TSF), a broad measure of credit and liquidity in the economy, quickened to 10.7 percent in March from 10.1 percent, pulling further away from a record low of 9.8 percent in December.

In March, TSF quadrupled to 2.86 trillion yuan from 703 billion yuan in February. GRADUAL POLICY EASING LIKELY

The central bank has already slashed banks' reserve requirement ratio (RRR) five times over the past year and is widely expected to ease policy further in coming quarters to spur lending and reduce borrowing costs, especially for small and private firms vital for growth and job creation. But policymakers have repeatedly vowed not to open the credit floodgates in an economy saddled with piles of debt - a legacy of massive stimulus campaigns in past downturns.

While the PBOC has been guiding money market rates lower in various ways, most analysts do not expect China to cut its benchmark lending rate unless conditions sharply deteriorate. A new Reuters poll forecast three more cuts to RRR of 50 basis points each in this quarter and the next two.

Many analysts believe the next cut is imminent, but China may be in no rush after the solid March readings, said Tommy Xie, China economist at OCBC Bank in Singapore. "Though the data could be distorted by short term lending, the mild increase in medium to long term loans shows that there is no urgency for China to roll out more measures at the current stage," Xie said in a note.

"We think the chance of an RRR cut in April is much smaller. The next window could be June," he added, noting four tranches of 1.35 trillion yuan in PBOC medium-term loans will expire in June and July. FISCAL STIMULUS

With an eye on debt levels, Beijing is leaning more on fiscal stimulus to support growth this year, with more spending on roads, railways and ports, and nearly 2 trillion yuan in tax cuts. But leverage has to go up in order for stimulus to work, economists at Bank of America Merrill Lynch (BAML) said in a recent report. They believe a moderate increase in public debt is manageable as long as it prevents a slump in growth.

China's top four state-controlled banks warned last month that bad loans could rise. Beijing is pushing them to boost lending to smaller businesses by at least 30 percent this year, though they are seen as higher credit risks. Smaller, regional banks may be more vulnerable to a new round of sour loans. The National Audit Office reported this month that some banks in the central province of Henan had recorded 40 percent of their loan books as bad debt by the end of 2018.

SIGNS OF STEADYING? Optimism over the outlook for the economy has improved recently. Strong bank lending is setting the stage for a possible bounce in investment in coming months, while business surveys showed factory activity returned to growth in March.

Washington and Beijing also have accelerated high-level talks to resolve their year-long trade dispute, though a deal is by no means certain. Still, many analysts say China is not out of the woods, yet.

While a weak credit cycle has bottomed out, the economic slowdown may not end until the summer, said Chen Long, China economist at Gavekal Dragonomics in Beijing. "Credit growth is a leading indicator...it could be a few months before other activities start to bottom out," he said.

Economic growth is expected to cool to around 6.2 percent this year, a 29-year low, according to a Reuters poll. The economy grew 6.6 percent last year. (Additional reporting by Stella Qiu Editing by Jacqueline Wong)

(With inputs from agencies.)