China's Debt Moves Will Fail

First, a deflationary move.
WSJ: China Places Cap on Local Government Debt
Chinese lawmakers have placed a 16-trillion-yuan ($2.5 trillion) cap on local government debt as Beijing looks for ways to address one of the major impediments to the world’s second-largest economy.

The Standing Committee of China’s National People’s Congress imposed a 600 billion yuan limit on the direct debt local governments are allowed to run up this year, the official Xinhua News Agency said late Saturday. That would be on top of 15.4 trillion yuan on debt owed by local governments as of the end of 2014, Xinhua said. The moves are the result of a new law requiring the government to limit local debt, it said.

The caps don’t include indirect liabilities, which officials said totaled 8.6 trillion yuan, according to Xinhua. The latest government estimate put China’s local debt load at 17.9 trillion yuan as of the middle of 2013, up from negligible levels just six years before, including debt held indirectly. Xinhua on Saturday said the local government debt balance grew by 40% last year compared with the first half of 2013, though it didn’t provide further details.
China's local governments are willing to borrow. They are creating bad debt, but they are borrowing. This is the opposite situation with private businesses, which are not borrowing. Capping credit at local governments will cap total credit growth.

Next, a seemingly inflationary move.
WSJ: China to Remove 75% Cap on Banks’ Loan-to-Deposit Ratio
China will remove a 75% cap on banks’ loan-to-deposit ratios on Oct. 1 following the adoption of a legal amendment by the national parliament on Saturday, according to state news agency Xinhua.

The ratio will instead be regarded as a liquidity monitoring indicator, according to the amendment passed by the Standing Committee of the legislature, known as the National People’s Congress, Xinhua said.

The 75% cap has been in place since its inclusion in a commercial banking law enacted in 1995, Xinhua said. China’s State Council, or cabinet, said in June that the ceiling would be scrapped in a draft amendment to the law.

Under current rules, Chinese banks must keep their loan-to-deposit ratios below 75%. For every dollar a bank collects in deposits, it can lend only 75 cents.
The cap doesn't matter for credit growth because banks create money when they issue loans. Lending creates the deposits, but when lending growth slows, it doesn't matter if you have deposits or not. It will ease the pressure to attract deposits though, which could go a long way to alleviating periodic cash crunches.

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