There is a giant debt bubble looming over the Chinese economy. Despite measures by the Chinese government to reform, China’s private sector rely heavily on state lending on state banks. With debt mounting at twice the rate of growth, I’ve decided to do an in-depth analysis into China’s debt and what it is made up of, to better understand the underlying factors of the second-biggest economy in the world.
China amounts to 1 out of the 3 percent growth of global GBP growth. The nation amounts to half of the demand for overall commodities. If China were to tumble into a recession it would create a vacuum that would suck the word down with it.
It is important to understand that the Chinese government is trying to slow the expansion of government debt. However, to do so, the government have had to curtail the amount of credit given. This halt on the flow of money has contributed to the slow-down of China’s economy.
This deleveraging is to help combat the debt expansion that helped stimulate growth that China has accumulated since 2007-2014 increase in credit. Which helped to increase growth in China.
China started to shift the focus of its economic stimulus from infrastructure and to consumption. The move is a difficult one, in that an overheated segment of an economy is hard to quench if there is still a profit margin to be made.
The obstacle that china faces is to cut off investment for overstimulated markets, such as their infrastructure market which has fuelled a property bubble. However, while reducing the credit available to more protective sectors, such as biotechnology. The problem in China is not over investment, it is that investment is imbalanced.
Leading on from that is the quality of china’s accumulated debt. There was a fast credit expansion of in China’s economy which gave way to the erosion of underlying standards.
Much of China’s debt stems from the private sector whose profitability is widely declined. China’s private sector is made up of mostly export-driven companies. The export industry is decreasing following global financial turbulence and weaker demand across the world. Additionally, much of the outgoing credit has been plunged into declining industries such as heavy industry.
The Chinese economy has entered into the Ponzi-phase of financing – whereby cashflows cover neither interest nor the principal or their loans – meaning that they are relying on the appreciation of their assets. Should this inflation not occur, the firms will be left exposed. Chinese companies are now acquiring new debt to pay for their previous debt.
If you want to slow down debt expansion you will slow down the expansion of the economy, which is the policy dilemma china faces today. Cutting off credit flow to the public sector will reduce investment, slowing down the economy.
Additionally, even though Chinese governments have been reducing interest rates, the interest expenses growth rate is still the highest amongst emerging economies, at 27.8%.
However, one of the main catapults of financial crisis in emerging economies in the past has been the accumulation of external or foreign debt. China paints a different picture to that, which a manageable external debt of when compared with GDP.
It is estimated that China accumulates 4 trillion dollars in foreign exchange reserves.
Budget deficit as a percentage of GDP is estimated to be about 18%, which again, is manageable. The government have the capital necessary to re-capitalise banks if needs be.
As the renowned economist, Hyman Minsky put it in his financial-instability hypothesis – periods of stability breeds periods of financial stability as markets find it impossible to resist the urge to take on more debt in times of financial growth.
China are in a cycle of this boom and bust periods however, its government seem to be equipped to recapitalise banks and pay back debt, if necessary.