The View

What’s the greatest risk to China’s economy? Look no further than its growing corporate and household debt

China has been one of the leading generators of debt since 2009, contributing to the latest worries over global inflation that have roiled markets

PUBLISHED : Friday, 16 February, 2018, 6:01pm
UPDATED : Friday, 16 February, 2018, 6:13pm

Few investors study history. And the ones that do, dismiss the lessons as being irrelevant for the current market. Predicting China’s upcoming economic collapse is a popular contrarian viewpoint, but it is not so easy to generate a convenient scenario if you look at data that is driving global inflation fears.

Credit is like a “ghost in the machine” for banks. It moves through their balance sheets and, ultimately, the markets without senior managers and traders knowing about the cumulative risk, lack of diversification and liquidity problems until it is too late. Much of the new technology being employed by globally and systemically important financial institutions since the global financial crisis along with new rules by BASEL is supposed to better capture and quantify risks.

But China represents a complex case of politically controlled banks whose concept of risk control is vastly different from their western counterparts. Examining the source of credit growth points to its possible future risks.

So far, China’s pile of debt (28 trillion yuan, or US$4.3 trillion), equivalent to about 41 per cent of gross domestic product as of March 2016, is managed by issuing more debt. Economic expansion can only continue by printing more money – credit expansion. The risks, as we saw in 2008, are financial mania followed by sharp declines as one sector like subprime loans collapses and ripples across the markets and economy.

Analysts have mostly focused on China’s GDP growth. But China has been one of the leading generators of debt since 2009. So it is also a contributor to the latest worries over global inflation that have roiled markets and upset traders. Recent Chinese new loan data explains how China is creating more debt to fuel its economy.

According to the People’s Bank of China in January, China created a record 2,900 billion yuan in new loans (US$458.3 billion), 900 billion yuan above the projected 2,000 billion yuan. Corporate loans rose to 901.6 billion yuan in January from 329.4 billion yuan in December.

Deutsche Bank data shows that companies and households appear to have geared up. In January, new credit comprised 66 per cent corporate and 29 per cent household debt versus 43 per cent and 28 per cent, respectively, in December 2017.

As it encourages loan expansion, Beijing has rolled out more policies in January to restrict riskier financial operations that have been supported by loose lending. China continues to police the shadow banking sector with strong regulatory and enforcement measures. So growing corporate and household debt levels must be dealt with alongside chronic bad state loans and “zombie” companies. Even the IMF has warned that China’s inability to control expanding debt increases the risk of a financial crisis.

Then, couple China’s debt problem with another debt-laden ambition, the One Belt One Road project, which increasingly looks financially impractical as the terms of the sovereign infrastructure loans fail to meet client restrictions and risk pricing. Last year’s rejection of Chinese financing by Nepal and Pakistan after a last minute introduction of new guarantees and terms highlights the project’s key problem – after all the glorious banquets and toasts who is going to pay for the bridges, roads and dams?

Without clear sovereign guarantees and commercially viable offtake agreements, China will effectively be giving outright infrastructure grants, something even the World Bank does not generally do.

Worst of all, China’s financial commitment to this string of sprawling infrastructure projects effectively crowds out domestic capital – raising the availability or cost for other equally important poverty alleviation and social projects in China such as hospitals, schools and roads. Eventually, provincial governors and bureaucrats will be asking why so much of the national treasure is being directed to developing countries when China, too, has pressing needs.

Meanwhile, the inflation versus deflation tug of war is being waged over US average hourly earnings growth, which is currently at 2.9 per cent, the highest since 2009. It has been the centre of recent attention as traders look for signs of higher inflation and rising interest rates. Yet, Beijing’s monthly new credit policies also threaten to fuel inflation in China and the rest of the world.

Since the global financial crisis, central banks have injected cheap money to revive economies and restore confidence in the financial system. The goal was to stimulate corporate borrowing, raise consumer spending and increase asset prices – all to fight the hazards of deflation and generate inflation.

Central bankers prefer to deal with the effects of inflation rather than deflation as the latter is much harder to combat.

Since 2009, price and wage inflation have remained low by historical levels. But, recent volatility could mean that these expectations are changing.