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 by state banks. With debt mounting at twice the rate of growth, Let’s 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 accounts for 33% of global GDP growth and the nation contributes to half of overall commodity demand. If China were to tumble into a recession it would create a vacuum that would reverberate globally.
Chinese government is trying to slow the expansion of government debt, especially in the overstimulated Property and Infrastructure industries. This halt of credit has contributed to the slow-down of China’s economy.
The obstacle that China faces, is to curtail investment for overstimulated markets, averting a Property Bubble, whilst providing capital for under-productive sectors such as Biotechnology and E-commerce. The problem in China is not over investment, but instead investment imbalance.
Leading on from that, is the quality of China’s accumulated debt – rapid credit expansion gave way to the erosion of lending standards.
Much of China’s debt stems from the Private sector, whose profitability has widely declined. China’s Private sector is primarily based on export-driven companies. The export industry is decreasing following global financial turbulence and weaker demand across the world. Additionally, much of the issued credit has been plunged into declining sectors such as heavy industry.
The Chinese economy has entered into Ponzi-phase financing – whereby cash-flows 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, firms will be left exposed. Chinese companies are now acquiring new debt to pay for their previous debt.
Additionally, even though the Chinese government has been reducing interest rates, the interest expenses growth rate is still the highest amongst emerging economies, at 27.8%.
However, the Chinese budget deficit as a percentage of GDP is estimated to be about 18%, which is low in global terms and it’s estimated that the government have the capital necessary to re-capitalise banks if necessary.
As the renowned economist, Hyman Minsky put it in his financial-instability hypothesis – periods of stability breeds periods of financial instability, as markets find it impossible to resist the urge to take on more debt in times of financial growth.
The challenge for the Chinese government is to manage this period of financial instability as the country undertakes the shift of their economic focus.