China learns from the past to avoid financial crisis

By Shen Jianguang Source:Global Times Published: 2017/6/5 21:23:39

Illustration: Peter C. Espina/GT


Moody's Investors Service recently announced that it had lowered China's rating from Aa3 to A1 on the grounds that as the country's economic growth slows, the fiscal position will weaken in the next few years and debt levels will continue to rise. This prompted bearish sentiment toward the Chinese market, dragged down offshore yuan rates and increased pessimism about China among global investors. In fact, over the past decade, this kind of bearish forecast has been common among institutions such as the IMF and some overseas hedge funds, as well as institutional investors. Overseas investors have discussed for many years whether China will experience a "Minsky moment" - a precipitous drop in asset values.

Recently, I was asked by overseas investors in the US about a potential financial crisis in China. Many indicators show that China's economy is under pressure, such as the oversized shadow banking system, the huge amount of credit in the property sector, inflated asset prices, risky online lending platforms and the inflexibility of the exchange rate policy. But why hasn't China suffered a crisis? And how can we explain the fact that China's growing debt level has not caused a financial crisis?

As far as I am concerned, China's proven record in crisis prevention is related to learning the profound lessons from global financial crises in the past and avoiding the same mistakes. There are three examples of this.

First, a one-time devaluation can lead to a crisis. For instance, when Thailand dropped its peg to the dollar system in 1997, the decision was praised by the IMF, but then the exchange rate experienced great turmoil with the Thai baht falling by 60 percent. This led to a serious national economic recession. In China, since the reform of the foreign exchange rate system in 2015, the yuan has faced considerable depreciation pressure, and voices calling for a one-time large devaluation became louder and louder. However, having learned from the Thai crisis, China's decision-makers took measures to avoid a substantial devaluation of the currency.

Earlier this year, as China's foreign reserves dropped below $3 trillion, there was a wave of panic once again. Whether to defend the current exchange rate became increasingly controversial, and the central bank was questioned over its measures to push yuan internationalization. But after measures to manage capital outflows were taken, the yuan stabilized, capital outflow pressure eased and the central bank continued with the internationalization of the yuan. This shows that China has learned from previous experience to avoid its own crisis.

Second, there is risk in deliberately puncturing an asset bubble. In the 1990s, the Japanese real estate bubble burst, leading to three decades of recession. Today, China's real estate bubble is also worth contemplation, but there are many differences between the two bubbles. For instance, the current level of urbanization in China is lower than in Japan, and unlike Japan, China did not experience significant devaluation after the Plaza Accord, nor the same phenomenon of large-scale industrial relocation. More importantly, the Chinese government has learned the lessons from the Japanese real estate bubble and has avoided following the path taken by Japan of aggressively increasing interest rates and puncturing the bubble. Instead, against the background of bubble accumulation, China firstly took administrative measures to suppress the momentum of rising prices without piercing the bubble, and it enhanced income levels and improved fundamentals to keep the real estate market stable.

The third example is government bailouts of large institutions. The impact of the global financial crisis in 2008 was far-reaching, and the world still has not completely recovered. Some people believe that if the US Federal Reserve had been able to rescue Lehman Brothers before its collapse, as it later did with Citigroup and other institutions, the financial crisis may not have been as serious as it was. In China, it is hard to imagine the government would allow an event like Lehman's bankruptcy to happen. The advantage of the Chinese model is to avoid a short-term crisis, but the medium-term risk is an increase in moral hazard. How to balance these two issues has long been a common operating difficulty for central banks.

Apart from using short-term measures to avoid a crisis, other efforts including supply-side reform, State-owned enterprise reform, land reform, tax reform and other deep-seated reforms will be needed for China's longer-term security.

The author is managing director and chief economist with Mizuho Securities Asia.


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