• Tue
  • Dec 23, 2014
  • Updated: 9:39am
CommentInsight & Opinion

Rumours of a Chinese crash are greatly exaggerated

Yu Yongding says predictions of a Chinese economic crash fail to allow for Beijing's room to manoeuvre, first in neutralising the catalysts for collapse, then in limiting the damage even if it happened

PUBLISHED : Wednesday, 16 April, 2014, 5:12pm
UPDATED : Thursday, 17 April, 2014, 1:47am

The market is always in search of a story and investors, it seems, think they have found a new one this year in China. The country's growth slowdown and mounting financial risks have spurred a growing wave of pessimism, with economists worldwide warning of an impending crash.

But dire predictions for China have abounded for the past 30 years, and not one has materialised. Are today's really so different?

The short answer is no. Like the predictions of the past, today's warnings are based on historical precedents and universal indicators against which China, with its unique economic features, simply cannot be judged accurately.

The bottom line is that the complexity and distinctiveness of China's economy mean that assessing its current state and performance requires a detail-oriented analysis that accounts for as many off- setting factors as possible. Predictions are largely pointless, given that the assumptions underpinning them will invariably change.

Consider China's high leverage ratio, which many argue will be a key factor in causing a crisis. After all, they contend, developing countries that have experienced a large-scale credit boom have all ended up facing a credit crisis and a hard economic landing.

But several factors must be accounted for in assessing whether this is China's fate. While China's debt-GDP ratio is very high, the same is true in many successful East Asian economies, such as Taiwan, Singapore, South Korea, Thailand and Malaysia. And China's saving rate is much higher. Ceteris paribus, the higher the saving rate, the less likely it is that a high debt-GDP ratio will trigger a financial crisis.

In fact, China's high debt-GDP ratio is, to a large extent, a result of its simultaneously high saving and investment rates. And, while the inability to repay loans can contribute to a high debt burden, the nonperforming-loan ratio for China's major banks stands at less than 1 per cent.

If, based on these considerations, one concludes that China's debt-GDP ratio does constitute a substantial threat to its financial stability, there remains the question of whether a crisis is likely to occur. Only when all of the specific linkages between a high debt burden and the onset of a financial crisis have been identified can one draw even a tentative conclusion about that.

China's real-estate price bubble is often named as a likely catalyst for a crisis. But how such a downturn would unfold is far from certain.

Let us assume that the real-estate bubble has burst. In China, there are no subprime mortgages, and the down payment on the purchase price required to qualify for financing can exceed 50 per cent. Given that property prices are unlikely to fall by such a large margin, the bubble's collapse would not bring down China's banks. Even if real estate prices fell by more than 50 per cent, commercial banks could survive - not least because mortgages account for only about 20 per cent of banks' total assets.

At the same time, plummeting prices would attract new homebuyers in major cities, causing the market to stabilise. And China's recently announced urbanisation strategy should ensure that cities' demographic structure supports intrinsic demand. If that were not enough to ward off disaster, the government could purchase unsold properties and use them for social housing.

Moreover, if necessary, banks could recover funds by selling collateral. As a last resort, the government could step in, as it did in the late 1990s and early 2000s, to remove non-performing loans from banks' balance sheets. Indeed, China has a massive war chest of foreign-exchange reserves that it would not hesitate to use to inject capital into commercial banks.

That remains a highly unlikely scenario. China's banking system does face risks stemming from a maturity mismatch between loans and deposits. But the mismatch is less severe than some observers believe. In fact, the average term of deposits in China's banks is about nine months, while medium- and long-term loans account for just over half of total outstanding credit.

A more salient threat would arise if the government pursued too much capital-account liberalisation too fast. If China eases restrictions on cross-border capital flows, an unexpected shock could trigger large-scale capital flight, bringing down the entire financial system. Given this, it is vital that China maintains controls over short-term cross-border capital flows in the foreseeable future.

Likewise, the Chinese government must address a fundamental contradiction. Monetary interest rates have risen steadily, owing to rampant regulatory arbitrage (whereby banks find loopholes that enable them to avoid unfavourable rules) and the fragmentation of the credit market, while return on capital has fallen rapidly because of overcapacity.

If the Chinese government fails to reverse this trend, a financial crisis - in one form or another - will become inevitable. But, given the authorities' broad scope for policy intervention, the crash will not come any time soon - if it comes at all.

Yu Yongding is a former director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, and has also served on the Monetary Policy Committee of the People's Bank of China. Copyright: Project Syndicate


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This article is now closed to comments

M Miyagi
For 3 decades, the US and her allies have been hoping for China to crash economically and socially but that haven't happened. The Asia financial crisis in 1997 caused South East Asia and Korea to crash. In 2008 the US induced financial crisis caused the EU and US to crash. While problems in China exists with the Shanghai and Shenzhen stock market being a laughing stock at least there is no bubble in the Chinese stock market where valuations are very low. After 4 rounds of QE, the US is headed for another financial and economic crash.
a classic case of jealously about china and obviously those self claimed expert commentators from western media are always talking about the imminent crash dat will happen and still waiting for it to happen.
none has brazenly spoken and predicted more than dat mr. gordon chang, author of the "coming collapse of china" have been preaching about the crash for more than a decade.....yes..folks...to be exact...13 years since published. pitiful I must say. likely chances of himself going bankrupt is higher than china collapse.
the law of physics will apply to any economic over a lengthy time. it does not take a scientist to figure dat out.
assuming if there is a crash, china has the $$$ to cushion the shock more comfortably than say America. they better pray it will not happen...otherwise, china will recall their loans...
america is living on credit…best they save $$$ to build their economies back on track rather than spending those $$$ on reckless and irresponsible adventure like the pivot to asia…
And China holds US debts. What an irony.
This kind of article presents a bit of a false choice, arguing that the only two potential outcomes are a disaster or smooth sailing. That China will have a debilitating credit crisis seems to be a low probability event. That relatively large credit write downs will occur appears to be a high probability outcome, one that even the Premiere has talked about. The discussion in China always comes back to why China is a special case. In many ways it is, particularly because of the high household savings and high corporate leverage. But there is nothing special about credit write downs and bad loans, however they are absorbed. Households should seen new investment opportunities as corporate China needs to recapitalize itself, but that is not consistent with the line of argument the Yu Yongding and many others make, that the transition costs associated with exiting an era of credit driven growth will be low. A financial crisis and costly financial clean up can be mutually exclusive.
there is good debt put to productive use. And there is bad debt swimming in empty buildings and vanity projects. Singapore's high debt to GDP ratio stems from the issuance of sovereign bonds to stir up the local fixed income market. Funds raised are invested for higher returns, and that has panned out well so far.


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