Some people think that China is heading toward a financial crisis as its GDP growth slows but its debt increases.
Barclays analysts Ajay Rajadhyaksha and Jian Chang recently published a paper on the increasing size of China’s finance and credit sector, and although they conclude that China is not likely heading into a sudden credit crunch they do provide some useful stats on just how inflated China’s financial sector has become. Such as:
- Property investment was 4% of GDP in 1997, now it is 15%.
- Investment (ie credit growth) is 46% of GDP, much greater than other emerging countries. It was only just over 30% back in 1996. The pair call this “a massive over-investment cycle.”
- The banking sector has tripled in size since 2008, and now stands at 200 trillion yuan (£22 trillion / $30 trillion).
- Chinese banks pumped a record 2.5 trillion yuan (£27 billion / $38 billion) into the economy in January alone.
Here is what that finance boom looks like in a chart:
Remember, this money is mostly in the form of credit or debt. And as long as the Chinese economy slows, those debts get harder to pay back. Rajadhyaksha and Chang suggest that if a credit crisis were to occur, it would happen this way:
The misallocation of resources is very likely in a credit boom of the size China has experienced, and it seems unlikely that China will prove an exception to this rule, in our view. Hence, we would not be surprised if the actual non-performing loans (NPLs) in the Chinese banking system are multiples of the official number of below 2%. But a credit crisis does not happen simply because NPL ratios rise above a certain level. In response to worsening credit performance, lenders need to strike and refuse to extend further credit; that is when rising defaults turn into a crisis. Solvency is fundamental, but a fear-driven refusal to roll over outstanding credits is what turns a financial headwind into crisis. Such a financing crisis can result from the sudden refusal of banks to roll loans further, a shutdown of debt capital markets, or simply wholesale funding being withdrawn (which happened to many US financial firms in 2008). Retail bank runs used to be another version of a lender’s strike, but that risk has diminished due to federal guarantees.
But — there is always a “but” — this is China, where the government has its finger in every pie. China has the ability to repeatedly roll over loans, even for creditors who look weak or shaky. So there is more room for manoeuvre than there would be in the West, where shareholders are less patient about getting their money back. That lenient liquidity means a crisis won’t happen soon. “Unless this funding stops, an imminent credit or banking crisis is unlikely. There seems no reason for it to happen this year, as many China bears have suggested,” Rajadhyaksha and Jian Chang say.
It’s interesting that Barclays is comparing China now to the US in 2008. Here is what happened in America back then:
No doubt the Chinese are aware of this and have figured a way out.
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