China may have problems, but this scare story isn't one of them

While alarmist talk of global meltdown sparked by a currency crisis at Chinese banks fires up doom merchants, the reality is more reassuring

PUBLISHED : Tuesday, 04 February, 2014, 5:57am
UPDATED : Tuesday, 04 February, 2014, 2:58pm

As a headline, it was certainly eye-catching. "Currency crisis at Chinese banks could trigger global meltdown," declared a story in the Sunday edition of London's Daily Telegraph.

The article noted nervously that foreign currency borrowing by Chinese companies has almost quadrupled in just four years to more than US$1 trillion.

Any substantial appreciation of the US dollar - and many analysts are indeed expecting gains this year - could open up a dangerous cross-currency mismatch, forcing Chinese borrowers to default and inflicting shattering losses on international lenders, the story warned.

Prognostications of doom always sell well, and for a time over the weekend this particular scare was the most read story on the Telegraph's website. Even yesterday it ranked as the most viewed business article, attracting hundreds of comments from worried readers.

Fortunately the Telegraph's troubled readers can set their minds at rest.

The chance that China will suffer a currency crisis at any time in the foreseeable future is precisely zero. And even if the country were struck by crisis, there would be no danger of a global financial meltdown.

It is certainly true that China's foreign liabilities have grown rapidly in recent years; a quadrupling since 2009 is about right.

But, if anything, the Telegraph's figure of US$1 trillion is rather too modest.

According to Beijing's State Administration of Foreign Exchange, at the end of 2013 China had foreign liabilities of a thumping US$3.85 trillion; roughly 40 per cent of its gross domestic product.

But the lion's share of those liabilities - some US$2.32 trillion - consists of highly illiquid inward foreign direct investment. That money is staying where it is.

On top of that, a further US$374 billion is foreign portfolio investment in China's stock and bond markets. That's money that has flowed in under Beijing's qualified foreign institutional investor programme, whose rules impose strict limits on the size and frequency of repatriation payments.

However, that still leaves around US$1.15 trillion in short-term foreign liabilities, consisting largely of loans from international banks.

That's a sizeable chunk of change in anyone's money. Clearly, as the Telegraph warns, any rapid appreciation of the US dollar could leave Chinese domestic borrowers badly out of pocket. But even nasty losses on foreign currency loans are nowhere near enough to precipitate a currency crisis.

To see why, just compare China's situation today with that of Indonesia in 1997.

Reassured by the rupiah's crawling peg to the US dollar and enticed by low offshore borrowing costs, in the boom years of the mid-1990s Indonesian companies ran up foreign currency debts worth more than 50 per cent of the country's GDP.

Worse, many of those debts carried only short maturities, so that by 1997 Indonesia's short-term foreign currency debts amounted to almost double the country's foreign exchange reserves.

The resulting loss of confidence was catastrophic. The rupiah crashed 85 per cent in value in just six months in a full-blown currency crisis that remains seared into the mindsets of policymakers across Asia.

In 2014, China has no such problems. External debt is small relative to GDP. And with US$3.82 trillion in foreign reserves at the end of last year, Beijing can cover China's near-term foreign liabilities more than three times over.

Sure, the shrinkage of the central bank's balance sheet were it actually forced to sell assets in order to fund the country's external liabilities would inflict a painful monetary tightening on China's domestic economy.

But with Beijing sitting on such a large pot of foreign reserves, such an extreme crisis is hardly likely.

And even if it did happen, there would be no "global meltdown". Despite the opening of recent years, Beijing's controls on the free flow of capital mean China's financial sector remains relatively closed, and the exposure of the global financial system to the country is low.

That's not to say there wouldn't be casualties from a sudden strengthening of the US dollar against the yuan, or from a marked slowdown in China's domestic economy. At the end of October last year Hong Kong's banking system was owed US$300 billion by mainland banks and another US$100 billion by mainland companies.

Clearly the local pain would be intense. But a Chinese currency crisis triggering global meltdown? Happily not.

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