Commentary by Nikhilesh Bhattacharyya

HAVING weakened sharply during the height of the global financial crisis, credit growth and private sector investment are recovering across Asia.

Seasonally adjusted estimates of credit growth in emerging Asia’s biggest economies show the pace of recovery varies dramatically across the region. In China loan growth has begun to slow after expanding at a breakneck pace earlier this year.

Credit growth appears to be recovering in India, though it remains well below its trend rate. The worst drought in over 30 years has dampened economic activity.

In the Asean economies, credit conditions vary markedly. In Indonesia, the latest data show weak credit growth in July, which is mainly a product of monetary policy transmission problems and banks tightening lending standards following a credit boom in 2008.

The diversity of credit conditions will influence the timing of central banks withdrawing monetary stimulus. Chinese authorities are facing the threat of surging credit growth feeding into asset bubbles and may already have begun influencing banks to scale back lending.

Recent comments from officials at the Reserve Bank of India (RBI) suggest rate hikes may come as early as January, despite a fragile recovery and below trend credit growth.

In contrast, central bankers in the Asean economies are still waiting for further signs of a sustained recovery and stronger credit growth before beginning to withdraw monetary stimulus.

Chinese lending slowing down
Since the middle of the year Chinese banks have begun to scale back lending. New loans data released (last) Thursday revealed a sharp month-on-month fall in October, which spooked some investors and led to the Shanghai Composite falling immediately following the data release.

Part of the decline in new loans was due to seasonal factors, with October traditionally a month when new loans tend to fall on a month-ago basis.

Taking into account seasonal factors, new loans appear to have still grown at a strong pace by historical standards. The value of new loans for October 2009 was the largest for any October month on record. This suggests that authorities are maintaining an accommodative monetary stance and are still providing stimulus.

Seasonally adjusted data indicate that Chinese banks are still extending credit at a fast pace. However, the month-on-month pace of expansion has begun to slow in recent months. This is to be expected, with a high-base effect weighing on month-on-month changes after a surge in lending earlier this year.

With authorities still wary about the sustainability of the recovery and worried about weak external demand, monetary policy is likely to remain accommodative and a withdrawal of monetary stimulus — via raising deposit ratios or raising lending rates — is unlikely until next year.

India’s credit recovery
Like much of the rest of the region, seasonally adjusted credit growth in India has begun to recover after slowing sharply in late 2008 and early 2009.

Based on seasonally adjusted estimates, credit growth has picked up sharply since the first quarter, but was still below trend in July. Falling lending rates and improving financial conditions have stimulated credit growth.

With inflation accelerating sharply in recent months, officials at the RBI have begun contemplating hiking rates, outlining the case for preemptive monetary tightening in their last monetary policy review.

The worst drought in over 30 years has led to a steep fall in agricultural output that has sharply pushed up food prices. Officials are worried that this will feed into inflation expectations, which is a bigger danger in India compared to other economies, since public sector wages are inflation- indexed.

The problems of sluggish investment spending and uncomfortably high inflation put the RBI in a tough position. At October’s monetary policy review, inflation expectations appeared to be anchored.

Provided agricultural output normalises and the spring (rabi) harvest does not disappoint, then inflation expectations should hopefully remain anchored, negating the need for rate hikes.

Raising borrowing costs would have the undesirable consequence of weighing on investment, which needs to expand rapidly to reduce the infrastructure bottlenecks that drag on India’s potential growth rate.

Indonesia’s transmission problems
While Indonesia’s economy has managed to expand at a comparatively rapid pace during the global recession, bank lending in the republic has slowed sharply.

After a credit boom in 2008, lenders late last year began to tighten lending criteria, fearing rising non-performing loans as global economic conditions weakened.

High borrowing costs also weighed heavily on credit growth, with monetary transmission problems leading to persistently high commercial bank lending rates.

Facing relatively benign inflation pressures, Bank Indonesia is expected to refrain from hiking rates till the second quarter of next year. As is the case in India, stimulating rapid investment spending is a major priority for Indonesian policymakers. Infrastructure bottlenecks are weighing on the country’s growth potential.

Despite a recent minor rise, central bank surveys suggest inflation expectations appear stable, negating the need for hiking rates at present.

Nikhilesh Bhattacharyya is an associate economist in the Moody's Economy.com Sydney office.