China Research

Recently, I read again that more skeptical analysts nowadays exaggerate their concerns about China. These words came – not very surprisingly – from a prominent hedge fund manager. I guess that this guy never had looked somewhat deeper into the Chinese debt problem.

I easily can agree that Chinese non-performing loans are a conundrum. However, the risks are most probably much more on the worse side than to the better. The Chinese have a gigantic debt problem which has been increasing during and in the aftermath of the subprime crisis to unsustainable levels, currently 200 percent according to official estimates and may be around 250-260 percent of GDP according to private sources. Nobody knows the exact number because of unclear definitions of loans, unknown local debt amounts in reality, implicit central government debt and hidden credit volumes of the shadow banks. I feel worried about this black box, particularly when considering that the above-mentioned credit ratio in 2008 still was as low as around 115 percent.

The credit boom contributed to artificial or doped GDP growth in the past seven years or so which certainly cannot be maintained anymore. Still, financing Chinese debt is not in danger since the money is created domestically without net borrowing abroad (as a result of the positive balance on current account). But what happens the day when China possibly cannot create surpluses in the current account anymore and/or the capital balance has been widely or completely deregulated? In a bad or worst case scenario – with free cross-border capital movements and debt crisis – bank refinancing could become much more difficult or even impossible.

There are, consequently three major risks arising from the Chinese credit boom:

¤  reduction of GDP growth if/when credit growth is slowing down,

¤  delayed or even strongly reduced deregulation plans of the cross-border capital balance and other financial reforms,

¤  explosion of an asset price bubble (property markets?).

Sure, nobody knows the end of this story. In my eyes, however, the analysis of the Chinese debt problem is widely a malign neglect, supported by the obviously too politically driven – quite benign – China analysis of the IMF.

Hubert Fromlet
Senior Professor of International Economics, Linnaeus University
Editorial board

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It seems, for example, credible that the role of the service sector has been strengthened more recently. This is a cornerstone in the new economic policy. The exact degree of this improvement is not known but the tertiary sector’s share of total production may now in reality be slightly more than 50 percent of GDP compared to roughly 40 percent for manufacturing (applying calculations by the National Bureau of Statistics).

Some further marketization of the financial sector and improvements in financial supervision can also be observed since 2014. The yuan has become a more international currency. Institutional shortcomings like corruption seem to be counteracted more strongly these days than in the past. The residential registration system (hukou) is about to be modernized, although probably not fast and broadly enough. Urbanization as a main driver of economic growth is going on, and let’s not forget the planned new Belt and Road Project with investment magnitudes that could become very high if everything goes to plan.  Focus on innovation, (mass-) entrepreneurship, e-commerce and other IT developments, pollution and the “new normal” with lower potential – but qualitatively better – GDP growth has been intensified by the Chinese decision makers and has also led to concrete measures.

An interesting detail is the introduction of a bonus and penalty system for pollution in an increasing number of cities in order to meet the compulsory government reduction targets of the current five-year plan. Further plans for pricing reforms should also be mentioned.

Thus, Chinese political decision makers are certainly not passive. Improvements have taken place recently and will happen in the future. However, insufficient reform steps and compromises will also be noted. Modern country and corporate analysis has to consider the promising parts of the reform policy but also the major difficulties that China will be confronted with in the forthcoming years.

Hubert Fromlet
Senior Professor of International Economics, Linnaeus University
Editorial board

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