Postponing the pain could prove costly for China
Growth cannot be sustained by increasing indebtedness indefinitely
A clerk at a branch of China Merchants Bank, in Hefei, Anhui: China will not have a financial meltdown, but reform and rebalancing are essential. Photograph: Reuters
Must China’s borrowing binge, like most others, end in tears? This is a hotly debated topic. On one side are those who predict a “Minsky moment” – a point in the credit cycle at which, as Hyman Minsky foretold, panic grips the financial system. On the other are those who insist China’s debt mountain poses no threat to economic growth: the authorities say it will be above 7 per cent and above 7 per cent it will be. Which side is right? Neither, is my answer. China will not have a financial meltdown. But the end of its credit addiction will lead to lower growth, properly measured.
Three facts about recent economic developments seem clear. First, if you take the official statistics at face value, China’s net exports shrank from 8.8 per cent of gross domestic product in 2007 to 2.6 per cent in 2011. This was offset by a jump in the share of investment in the same period, from 42 per cent of GDP – already high – to 48 per cent. There are reasons to doubt reported levels of investment, but it is less reasonable to question its abrupt rise.
Second, linked with the rise in the share of investment was an explosion in credit and debt. According to the International Monetary Fund, by the final quarter of last year total “social financing”, as Chinese authorities describe it, reached 200 per cent of GDP, up from only 125 per cent before the crisis. Moreover, much of this increase had been outside traditional banking channels. Instead, there has been explosive growth of what one might call a “shadow banking system with Chinese characteristics”. This does not rely on the complex securitisations or wholesale markets now notorious in the west, but on new intermediaries, such as trusts, and innovative instruments, such as “wealth-management products”. According to Fitch, credit outstanding to the private sector is now as big, relative to GDP, as it was in the US in 2007.
Third, China’s growth rate has slowed from 10 per cent or more in the past decade to about 7 per cent in 2012 and 2013. This is still high, but not as high. Imagine being told of an unnamed economy with soaring investment and credit, but falling growth; with a rising proportion of investment activity funded by debt, but falling returns. You would expect an unhappy ending.
Some argue “this time is different”. Peter Sands of Standard Chartered notes differences from precrisis conditions elsewhere: China has borrowed to fund investment, rather than consumption; companies are the main borrowers; the country is not dependent on foreign lenders. In addition, the renminbi is not freely convertible into foreign currency.
The first two points are weak. Minsky’s theory of financial instability was about corporate finance. Moreover, the debts that loomed so large in the US in the 1930s and Japan in the 1990s were also largely corporate. The quality of the investment is what matters, and on this there are reasons for doubt. A recent IMF study argues China may have been overinvesting by 12-20 per cent of GDP. Some of the money spent on real estate and industrial capacity is likely to have been squandered.