Debt, shadow finance bedevil China’s economy
Analysts warn that China needs to tackle ballooning debt, private wealth products
Decades of breakneck expansion have given China gleaming skyscrapers and sleek railways, but brought piles of debt and dubious financial instruments analysts say are a potential time bomb that could strike a blow against global growth.
Worries centre on trillions of dollars of unsustainable government borrowing, especially by local authorities, that has underpinned the country’s investment-based economy.
At the same time non-traditional forms of lending labelled “shadow finance” have emerged as a counter to China’s tightly regulated banking system, and are also in the trillions, and growing fast.
“They are very serious issues right now,” said Oliver Rui, professor of finance and accounting at the China Europe International Business School in Shanghai.
China’s new leaders, keen to bring the threat under control, are “concerned that if they delay reform then sooner or later the issue will get out of hand”, Rui added.
For decades, China’s growth model has been based on leveraging its cheap and abundant labour force to manufacture products for export, alongside credit-fuelled domestic investment to develop infrastructure.
But stresses are starting to show and the government as well as international observers say the system needs to change so China can engineer a so-called soft landing and ensure stable and sustainable economic growth.
President Xi Jinping and Premier Li Keqiang, China’s top leaders since March, say the old pattern is no longer viable and what China needs is to build up consumer demand as the economy’s key engine.
The International Monetary Fund (IMF) last week estimated for the first time what it called “augmented debt”, or the combined obligations of both central and local governments, at 45 per cent of gross domestic product (GDP).
“Further rapid growth of debts would raise the risk of a disorderly adjustment in local government spending. This would drag down growth, with adverse global spillovers,” it said in a report.
Chinese provincial and municipal governments have borrowed vast sums, often with little thought as to how they will be repaid, to spend on infrastructure projects that give local economies a short-term boost. However, many of them fail to generate adequate long-term returns, such as the country’s notorious “ghost cities”.
Moody’s Investors Service calculated this year that China’s shadow banking sector could be as large as 29 trillion yuan (HK$36.4 trillion), or 55 per cent of GDP at the end of last year.
The term refers to loans and investment products sometimes issued by legitimate banks and financial institutions, as well as private deals between individuals or companies, that have arisen as a way of getting around strict banking rules.
“Such a non-transparent, less regulated form of credit extension can stoke asset bubbles and may pose risks to financial stability, as highlighted in recent years,” Moody’s said, referring to US and European banks’ sub-prime lending woes that triggered the 2007-2009 global financial crisis.
China began taking steps to free up its lumbering, Soviet-style command economy in the late 1970s. Decades of stunning growth, rising trade and foreign investment resulted, pulling some half a billion people out of poverty.
But the economic and financial system is still run by the same secretive and elite Communist Party, and in many ways remains remarkably closed to the outside world given China’s size and influence as the globe’s second-largest economy.
The yuan currency is a long way off from full convertibility, while the government maintains a tight grip on the traditional banking system, with key institutions state-owned and tightly controlled.
Andy Xie, a Shanghai-based independent economist formerly with Morgan Stanley, says that while China’s banking system may look superficially similar to those of other countries, it is fundamentally different.
“The financial system doesn’t have a say about whom to give money to,” he said.
While the term shadow finance may evoke nefarious dealings done in back rooms, it is actually anything but, say experts.
Markus Rodlauer, the IMF’s mission chief for China, told reporters that much non-traditional finance was “really innovative new forms of financial intermediation”.
But while they have their “good sides”, he said, they “also have their risks”.
“Bank supervisors can’t really keep up with the new instruments and the fast growth,” he said. “It creates questions for credit quality, liquidity management”.
Though economists see the problem as serious, they also say that if defaults on local government debt -- which have so far not happened -- begin to ripple through the system, the government has plenty of ammunition to contain them.
Rodlauer said the IMF’s augmented debt calculation did not take into account factors such as state-owned assets and financial holdings, such as China’s US$3.5 trillion in foreign currency reserves, the world’s largest.
Xie, the independent economist, believes the Xi-led government is serious about dealing with the problem. And in China, he stressed, the government essentially owns the financial system.
“The banking system obviously cannot go bust,” he said. “If something happens the government will recapitalise.”