Does China’s debt signal an impending crisis?

Source:Global Times Published: 2016/9/21 0:33:39

Illustration: Peter C. Espina/GT

The Swiss-based Bank for International Settlements (BIS) warned on Sunday of the mounting risk of a serious banking crisis in China in the next three years. In its quarterly report, the bank said the credit-to-GDP gap, a key warning indicator of credit vulnerability and financial crises, rose to a record high of 30.1 for China in the first quarter of this year, the highest of any other major country tracked by the bank. The figure is three times higher than the threshold of 10 which the BIS believes foreshadows a financial crisis occurring "in any of the three years ahead."

According to the Chinese Academy of Social Sciences, China's total debt rose to 168.48 trillion yuan ($25.26 trillion) by the end of 2015, accounting for 249 percent of the country's GDP, up from 147 percent at the end of 2008. This debt-to-GDP ratio compares with the eurozone figure of 271 percent, the UK figure of 266 percent, the Japan figure of 394 percent and an average level of 279 percent for all developed economies.

The surge in China's debt level has attracted the attention of China's economic circle and central government. Analysis and discussions about the figure have been flourishing. The consensus of the government and private sectors on the issue is that there is a need for China to keep its debt level under proper control. But the mainstream opinion is that the current debt level is still controllable. There are three factors which can support this optimistic view. First, the biggest borrowers in China are enterprises, mostly State-owned enterprises. Many of them have assets to secure loans and thus are capable of paying back their debt. Second, China has a huge foreign exchange reserve and the government has a great strength in mobilizing resources and addressing contingent exposures in the financial system. Third, a portion of China's credit flows to its production sector, unlike in Western countries where governments borrow massively to pay for social welfare benefits. In China, debt can usually generate new assets.                            

Further, China's social structure differs significantly from that of Western countries. That means the way a crisis occurs in China and the path along which a crisis transmits is quite different from in the West. In China, we still see the subtle interplay of the market and the State as the country is in a process of transitioning from a planned economy to a market economy. It is still a priority for China to maintaining political stability and the government's authority. Key economic issues will likely be closely watched and monitored by the State. The central government has the ability to take resolute measures to address any problem before it spirals out of control and triggers alarms. The market elements in the economy will eventually cooperate under the guidance of government policies. 

Some Western institutions and media outlets have never ceased predicting a hard landing for the Chinese economy or even a cliff-diving crisis in the country. Most of the predictions have been proved wrong. The main reason is that they don't understand the fundamental features of China's economy. Sometimes, these observers don't even really understand China's economic data but draw a conclusion by applying Western historical experience.

The warnings by some Western institutions had indeed wracked the nerves of some Chinese people initially. But gradually, they came to realize the difference in the social and economic structure between China and Western countries and learned that a similar economic phenomenon may metamorphose in a different context. Chinese people have increasingly remained unruffled about the gloom-mongering predictions of the Chinese economy.              

We tend to believe such an attitude is advisable because we are no longer wary of every pessimistic analysis about China's economy and don't see every comment as the "coming collapse of China." Western observers have their own perspective and for many occasions we can rationally engage in discussions and talks with them and try to find out if there is anything useful for China.  

The credit-to-GDP gap measures the difference between the current credit-to-GDP ratio and its expected long-run trends. The 30.1 reading for the first quarter indicates that China's credit is expanding rapidly and such information is a valuable find although the BIS' conclusion may be an exaggeration and distort some facts. What should deserve our attention is whether the rapid credit expansion is a result of the government's macroeconomic control measures, where the credit flows to, whether the credit level goes in tune with the annual economic goals and if there is any connection to runaway property prices. These questions remain to be tested and answered.       

China's booming economy is on solid backing and the engine driving China's rise. Economic security is the pillar and foundation of China's national and social security. It is absolutely necessary for China to be vigilant to any irregular movement in the economy. But from a long-term perspective, such prudence will never conflict with our initiative to maintain the confidence of Chinese society in the economy.

This article is an editorial from the Global Times Chinese Edition.

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