Unlike advanced economies, China remains better positioned to overcome its debt challenges, due to the nature of is debt, level of development and economic fundamentals. Change is coming – but after fall.
In recent months, China has managed to stabilize growth. Nevertheless, stabilization has required capital controls, continued lending and repeated interventions. Due to efforts to stabilize the renminbi, for instance, China’s foreign-exchange reserves fell to $3 trillion last month; the lowest since spring 2011.
Some observers have concluded that China has opted for a path that proved so costly to Japan in the 1990s and the US in 2007. Yet, realities are a bit more complex.
Dramatic (local government) credit surge
Certainly, Chinese credit surge has been extraordinarily rapid in historical terms. In 1994, Japan’s plunge was preceded by decades of lending. In 2007, the US recession was fueled by a massive debt pile that had accrued in three decades. In China, debt involves local government debt, which accumulated after the 2009 stimulus package.
During the Great Recession, China’s huge stimulus boosted confidence, supported the infrastructure drive, and prevented a global depression. But excessive liquidity led to speculation in equity and property markets.
As lending continues to boost state-owned enterprises (SOEs), China’s private debt to gross domestic product (GDP) ratio surged to 205 percent in 2015, which exceeded the ratio in the US (166%) and came close to Japan (214%).
These figures should be understood in the context, however. Since China’s government debt is low (16%), its total debt was less than that in Japan (281%) and the US (247%).
The most far-reaching differences, however, involve different levels of economic development.
Japan and the US are advanced economies, which enjoy relatively high living standards, but suffer from low growth and secular stagnation.
Unlike Japan and the US, China is an emerging economy and its growth rate remains over 3 times faster than that of the US and its growth potential remains substantial in the next 5-15 years, given peaceful regional conditions.
Savings, trade balance, external debt and debt plans
Domestic savings rate is vital cushion in times of deleveraging. In the past four decades, Japan’s savings rate has plunged dramatically (from 40% in 1970s to 18% today). Recently, it has enjoyed trade surplus, but only after substantial depreciation of the yen. In the US, domestic savings rate is low (17%) and the country has run trade deficits for 40 years.
In China, the reverse prevails. Until recently, savings rate has been relatively high (close to 50%), and trade balance remains on the surplus.
Total internal debt must also be seen in the light of external debt (foreign debt), which is the total debt a country owes to foreign creditors. In emerging markets, high external debt has typically triggered major crises. Yet, China has little external debt (8% to GDP), unlike the US (100%) or Japan (171%).
Unlike major advanced economies and other large emerging economies, China is also seeking to reduce its debt pile, by converting short-term bank debt into long-term bonds and redirecting credit to the private sector and households. In contrast, the US lacks a credible, bipartisan and medium-term debt-cutting plan, while Japan has opted for a huge monetary gamble, which is boosting its national debt.
Expect change – but after fall
Nevertheless, China can no longer rely on credit-fueled growth. So will things change and if so, when?
While economic reforms have been initiated in the past half a decade, they are likely to be fully implemented by the 19th Central Committee, which will be elected in the fall. Since economic change will not be sustained without political consolidation, leadership transition is likely to precede reform implementation.
China’s current credit target (13%) remains twice the growth rate (about 6.7%). As long as the gap between credit-taking and growth rate is substantial, it will continue to penalize the quality of growth.
The original, slightly shorter version was published by Shanghai Daily on January 11, 2016