A mysterious official from China's ruling party is worried about the country's debt explosion

Dry drought tree desertPixabay via Google ImagesIt can’t grow to the sky …

Even China’s ruling party is starting to get worried about the build-up of debt in the Chinese economy, according to a recent interview in the People’s Daily, China’s more important newspaper.

According to the interview — which we first noticed thanks to the Financial Times — an unknown, but “authoritative” official from the ruling Communist party, says that the party is worried about the potential effects of high leverage in the Chinese economy.

“A tree cannot grow up to the sky — high leverage will definitely lead to high risks,” People’s Daily says the official said. “Any mishandling will lead to systemic financial risks, negative economic growth, or even have households’ savings evaporate. That’s deadly.”

The warning is one of only a few to come from a party official in recent years about the state of China’s debt build-up, which is causing huge concern to analysts, including Macquarie’s Viktor Shvets, who warned at the end of April that unless China’s “vicious cycle is broken, financial crisis or at least a sharp slowdown is an inevitable ultimate outcome.”

On Monday, a note from Japanese securities firm Nomura went into a little more depth on the People’s Daily piece. Here’s an extract from economists Yang Zhao, Chang Chun Hua, and Wendy Chen (emphasis ours):

Considering China’s severe structural problems, this “authoritative” person believes that “China’s economic growth trend in future should be ‘L-shaped’, rather than ‘U-shaped’, not to mention ‘V-shaped'”, which suggests that growth will trend lower. This individual believes China should avoid using strong stimulus to raise investment growth in the short term, as it would create larger problems later. For now, the most important thing, in this person’s view, is to push forward supply-side reforms (i.e., cutting over-capacity, reducing property inventory etc.) and actively but steadily reduce leverage.

China’s ballooning debt is becoming a source of increasing worry across the globe. Along with Macquarie’s worrying prediction, several other banks have also chipped in. Last year, for instance, Goldman Sachs cited Chinese debt as part of the so-called “third-wave” of the 2008 financial crisis, and just last week the bank produced three charts to show just how vast China’s debts are.

One of the charts showed more than $1 trillion of credit being issued in Q1 of 2016 alone, which any way you look at it, is huge.

While it may seem like a huge deal to get a warning on the economy from China’s notoriously closed rulers, the party does have a precedent in speaking to People’s Daily about certain economic issues, Nomura points out:

We note that the People’s Daily has in the past cited “an authoritative person” when discussing top-level policy issues. Two examples within the last year include an article on 25 May 2015 in which five questions related to the economy were discussed, and on 14 January 2016, when seven questions on supply-side reforms were addressed. While the anonymity has been protected, the views expressed in these articles did have a large impact in China.

But just how worried do we need to be about an impending banking crisis or major financial collapse? Not too worried right now, Nomura’s economists say, as long as the government’s reforms to the financial sector are done properly. Here’s their conclusion (emphasis ours):

Overall, the report suggests to us that future policy easing may be more cautious and that the government may try to hasten the pace of reforms, thus reinforcing our view that the debt-fuelled rebound in investment growth will be short-lived. We maintain our view that investment growth will likely slow later this year and reiterate our forecast for GDP growth to slow to 6.2% in 2016 and 5.8% in 2017.

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