CFP A large amount of new loans did not go to the real economy and may bring about very negative effects. —Zuo Xiaolei, Chief Economist of China Galaxy Securities Co. Ltd.

In the first half of this year, aggregate new loans had reached a record high of 7.37 trillion yuan ($1.08 trillion). Where has the vast amount of the new loans gone? Has ballooning credit really helped fuel economic growth? Or has it worked to produce capital bubbles? Zuo Xiaolei, chief economist of China Galaxy Securities Co. Ltd. based in Beijing, offered her opinion in the Shanghai Securities News. Edited excerpts follow.

Statistics released by the People's Bank of China (PBC) revealed the aggregate new loans in the first six months stood at 7.37 trillion yuan ($1.08 trillion), much more than the broad money supply (M2) which grew 28.46 percent year on year. This has evoked disputes about whether all the new loans have entered the real economy and worries about negative effects arising from the credit expansion. Statistics from several different categories may help us form a clear picture and trace the new loans. From my point of view, a large amount of money did not go to the real economy and may bring about very negative effects.

First, company savings increases shall undermine the effect of monetary policies.

The surge in company savings demonstrates the possibility of re-depositing bank loans. According to the PBC, in the first half of this year, company savings increased by 5.3 trillion yuan ($778.3 billion), a growth of 3.8 trillion yuan ($558.8 billion) year on year. By a sharp contrast, the enterprise profit witnessed a negative growth, which made its increase in savings sound less appealing. In this sense, we cannot rule out the possibility that not all the new lending had entered the real economy or that a major part of company loans has been flowed back to banks in the form of deposits.

Company loan re-depositing, if in current terms, will not cause major troubles since current accounts may go toward investment in the real economy and will haul up economic growth at the present stage.

But company loan re-depositing, if in fixed terms, will hardly have any direct effect on enhancing economic growth. For that reason, we have to be conservative in judging the driving force of loan surges on economy. That is to say, the 7.37-billion-yuan loan increase will not give the same impetus as we had expected.

Second, money inflow into the stock and property markets incurs systematic risks for banks.

As we all know, speculative investment will push up home prices, which has proven to be true by the home price increase in recent months. According to the National Bureau of Statistics, among the funding sources of property developers in the first six months, loans from domestic banks totaled 538.1 billion yuan ($79.1 billion), an increase of 32.6 percent year on year; individual mortgage loans 282.9 billion yuan ($41.6 billion), an increase of 63.1 percent year on year.

The soaring home prices at present have almost reached the same level as the record high in 2007. Such high prices have exceeded the ability to afford for those "rigid demands."

Therefore, I can tell that the boom in property industry was the result of speculative investment. The speculators attempted to earn big money by buying and selling. Since the home they bought was not for real habitation, no decoration will be made, thus there was no impetus on decoration consumption. As a consequence, speculative mortgage loans should not be deemed as promoting the real economy.

What made things even worse was that the rise in home price sent the wrong signal that the property market has gotten warm again, during which time the developer started to buy land at incredibly high prices and banks also started to loosen credit conditions for the real estate sector.

Who is going to pay for all these costs in the future? Once the home market begins to beg, the bank will be the sufferer. By that time, the bank will witness a dramatic increase in its bad debt.

If speculators invested in homes with their own capital, the price, no matter how high or low, would not cause considerable problems. But if mortgage loans were involved in the investment, the problem will be quite serious. The bank risks were virtually the same as the systematic risks of the whole economy. The financial crisis which had almost devastated Wall Street was directly caused by their deep and wide involvement in the subprime mortgage loans.

Taking control of bank's capital support for speculation is key to stabilizing the property market and preventing risks in the financial and economic systems.

By far we have not received official statistics to give evidence to the loan inflow into the stock market, but if we keep a close look at the money inflow and outflow in the Shanghai and Shenzhen stock markets, we can tell that the vast loan inflow has provided the driving forces for the recent bullish stock market.

Pushing up the stock market by bank loans puts the financial system at immense risk. The 70-percent decrease in the stock market last year did not have a substantial influence on the economic and financial system in that a stock bubble was not produced by bank loans.

What's more, we should not neglect that reasons at three levels may explain why funds and loans failed to flow into the real economy.

At the micro level, bank loans were mainly provided to state-owned enterprises (SOEs). Rich in funds, SOEs re-deposited the lending, which will not help achieve the goal of fueling economic growth through monetary policies. Therefore, banks should issue more loans for those fund-thirsty small and medium-sized enterprises and private companies, so that more private investment will enter into the market, thus promoting economic growth.

At the macro level, according to the PBC data, by the end of June 2009, M2 had grown 28.46 percent year on year to 56.89 trillion yuan ($8.37 trillion). Taking the 8-percent economic growth rate and 2-percent inflation expectations into account, the M2 increase in June outdistanced the money increase needed for normal economic operation by 18 percentage points. That is to say, the extra money supply rushed into the capital market and propped up capital prices, thus bringing banking risks. Monetary policies should be focusing on taking back the excessive money supply to avoid future troubles.

At the policy level, if we don't trace the money flow clearly, we cannot make a correct judgment on the future economic situation and we may not be able to implement appropriate economic policies.

The analysis above has denoted a monetary policy adjustment, if even a moderate one, is needed. But we should not forget that the economy has not completely recovered yet and private investment is still not strong enough. Against this background, any change to benchmark interest rates will do more harm than good, so I don't think the central bank will make any substantial changes.

As an alternative, a more transparent market, targeted issuance of central bank bills, increasing reserve requirement ratios when necessary, and controlling over the new lending scale will be the viable ways for the central bank to take in the next half of the year.