China has a huge debt problem but analysts at Nomura have come up with a radical series of policies to solve the problem, including sparking defaults before they would normally happen.
Craig Chan and his team at Nomura released a note on Tuesday entitled “China: Solving the debt problem.”
They laid out some key ways in which China could pull itself back from the brink of a major crisis:
1. Orderly defaults — Nomura says that China’s government needs to enact this measure, which is usually reserved for acute crises. Famous economist Nouriel Roubini floated this idea in 2010 when it came to Greece’s horrific sovereign debt crisis.
The idea is that regulators and lenders of the debt actively plan and implement defaults through restructuring of public debt before they naturally happen, in order to have some form of control over a fallout. Some economists argue that in times of crisis, an orderly default will hurt in the short-term but will be preferable for long-term stability.
2. Let the government take on state-owned enterprise (SOE) debt — SOE debt is a major problem for China. In May this year, credit rating agency Moody’s warned that debt of this kind “is higher than in any other rated nation and failure to curb risks from these liabilities would curb growth, lower credit availability and ultimately lead to state support.”
And Nomura says that, now, “increasing defaults on SOE debt is inevitable.” This is particularly worrying considering “SOEs account for almost 48% of bank loans to corporates, but only account for 15% of employment.”
Nomura says that the government needs to take over some of this debt to manage some orderly defaults and bear the financial brunt to prevent further issues for the economy.
3. Reform SOEs and its financial markets — In turn, Nomura says “further reform of the financial system is necessary to reduce the market power of the state-owned banks that inherently prefer lending to SOEs.” In other words, a major shake-up to how China’s financial system operates is essential to really tackling the country’s problems.
4. Lower interest rates and weaken the currency — Lower interest rates makes borrowing cheaper and therefore servicing debt payments cheaper too. This should lead to fewer defaults overall.
This stimulates spending and pumps more money back into the economy. A weak currency could aid foreign direct investment as a weak renminbi makes investments attractive to outsiders.
These look like pretty radical steps but China is sitting on a massive debt timebomb.
In June, Li Yang, a senior researcher with a respected government think tank called the China Academy of Social Sciences said China’s total borrowings were more than double its gross domestic product (GDP) in 2015 at 168.48 trillion yuan (£19.3 trillion, $25.6 trillion).
China’s non-financial sectors (i.e., non-financial companies, households and governments) accounted for 158.5 trillion yuan, worth 231% of GDP.
China takes on huge amounts of debt in order to ferociously fuel its economic growth. But growth is slowing. China no longer puts up double digit GDP growth, and instead is putting up numbers like 6.7% for the second quarter. But even that is being debunked by a number of asset managers and analysts.
For example, Alex Wolf, an emerging markets economist at Standard Life Investment, which manages $360 billion in assets, estimated earlier this month that China’s economy has grown at a much slower rate of 5% per year.
As well as this, recent economic data from the country have been a bitter disappointment.
So while Nomura’s plan of attack may seem drastic, China has to make a decision before the foundations of its economy begin to tremble.
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