China’s climb­ing debt threat­ens global growth

Calgary Herald - - FINANCIAL POST - ENDA CUR­RAN AND CHRISTO­PHER ANSTEY

It used to be that when Amer­ica sneezed, the world caught a cold. This time around, it’s the risk of a sickly China that poses a big­ger risk.

The world’s sec­ond-largest econ­omy is now try­ing to ward off the snif­fles. While out­put is still grow­ing at a pace that sees gross do­mes­tic prod­uct dou­ble every decade, the prob­lem re­mains that much of that has been fu­elled by a mas­sive buildup of credit.

To­tal bor­row­ing climbed to about 260 per cent of the econ­omy’s size by the end of 2016, up from 162 per cent in 2008, and will hit close to 320 per cent by 2021 ac­cord­ing to Bloomberg In­tel­li­gence es­ti­mates.

Econ­omy-wide debt lev­els are on track to rank among “the high­est in the world,” ac­cord­ing to Tom Or­lik, BI’s chief Asia econ­o­mist.

That path may be what prompted out­go­ing Peo­ple’s Bank of China gover­nor Zhou Xiaochuan to warn of the risk of a plunge in as­set val­ues fol­low­ing a debt binge, or a “Min­sky Mo­ment,” ear­lier this month. Given that China is fore­cast by the In­ter­na­tional Mon­e­tary Fund to con­trib­ute more than a third of global growth this year, con­trol­ling China’s debt mat­ters far beyond its bor­ders.

There are two key com­po­nents of China’s credit clam­p­down, each pos­ing chal­lenges to pol­i­cy­mak­ers.

First is wring­ing out bets on prop­erty prices.

As Pres­i­dent Xi Jin­ping put it in a key­note pol­icy speech to the Com­mu­nist party lead­er­ship on Oct. 18: Hous­ing is for liv­ing in, not for spec­u­la­tion.

The lat­est data show that in some ar­eas, prices are still surg­ing in many cities de­spite a raft of mea­sures to make it harder for in­vestors to buy real es­tate with bor­rowed money. Xi’an, China’s an­cient cap­i­tal, saw home val­ues soar al­most 15 per cent in Septem­ber from a year be­fore.

It will be up to reg­u­la­tors to come up with mea­sures that de­liver on Xi’s man­date with­out tip­ping hous­ing into a down­ward spi­ral. Prop­erty crashes in the U.S., Ja­pan and U.K. over the past three decades am­ply il­lus­trated how dam­ag­ing they can be to economies.

The sec­ond key chal­lenge is progress in align­ing bor­row­ing costs with bor­row­ers’ abil­ity to re­pay — rather than with their re­la­tion­ship with the state.

China’s fi­nan­cial sys­tem has long let com­pa­nies that are sta­te­owned or are seen to be im­ple­ment­ing state ini­tia­tives get fund­ing more cheaply than oth­ers. That’s thanks to the as­sump­tion the gov­ern­ment would step in if needed to back them up. To help en­cour­age cap­i­tal to be de­ployed more ef­fi­ciently — and to pre­vent firms that are ef­fec­tively in­sol­vent keep go­ing thanks to con­tin­ued fund­ing — pol­i­cy­mak­ers have be­gun to grad­u­ally take away im­plicit sup­port.

In 2014, a so­lar-panel maker Shanghai Chaori So­lar En­ergy Science & Tech­nol­ogy Co. be­came the first Chi­nese com­pany to de­fault on a do­mes­tic cor­po­rate bond. Since then, even some state-owned firms have been al­lowed to de­fault. Han­dling that process is del­i­cate.

“If to­mor­row you sud­denly with­draw that im­plicit gov­ern­ment sup­port, you would get a freeze-up in credit flow,” said Ken­neth Ho, head of Asia credit strat­egy re­search at Gold­man Sachs Group Inc. in Hong Kong. “If they do it too quickly the sys­tem will col­lapse. They’ve been go­ing at the right speed.”

Ho an­tic­i­pates that the num­ber of de­faults al­lowed will go up, though doesn’t see any surge. “We’re in an up­ward cy­cle in terms of rec­og­niz­ing de­faults, but it’s a long cy­cle,” he said.

To be sure, China’s econ­omy con­tin­ues to defy pre­dic­tions of an ac­tual debt cri­sis or a hous­ing bust. In­stead, there are signs of a con­trolled eas­ing. Home prices in Septem­ber rose in the fewest cities since Jan­uary 2016, amid curbs on debt-fu­elled buy­ing.

A do­mes­ti­cally trig­gered cri­sis is un­likely, at least in the next five years, ac­cord­ing to a re­port by Ber­lin-based Mer­ca­tor In­sti­tute for China Stud­ies. “Trou­ble is more likely to come from some com­bi­na­tion of cap­i­tal flight and sud­den with­drawal of ex­ter­nal credit,” wrote Vic­tor Shih, a pro­fes­sor at the Univer­sity of Cal­i­for­nia at San Diego and au­thor of the re­port.

Still, few coun­tries that have ex­pe­ri­enced China’s pace of debt growth have un­wound things with­out some sort of crunch. In­vestors, com­pa­nies and gov­ern­ments around the world will want China to break that mould. An in­di­ca­tion of the rip­ple ef­fect China can have on global mar­kets came in 2015 when a de­val­u­a­tion of the yuan, fol­lowed by other changes to how the tightly con­trolled cur­rency is traded, sent shock waves through global mar­kets. The move trig­gered cap­i­tal to flow out of China, forc­ing au­thor­i­ties to burn through re­serves to sup­port the cur­rency.

While China’s pol­i­cy­mak­ers are preach­ing the com­mit­ment to tackle debt, not ev­ery­one is con­vinced.

Some an­a­lysts say au­thor­i­ties aren’t go­ing hard enough.

“There is no delever­ag­ing,” Luke Spa­jic, head of port­fo­lio man­age­ment for emerg­ing Asia at Pa­cific In­vest­ment Man­age­ment Co., said at The New Ren­minbi Re­al­ity Sum­mit or­ga­nized by Bloomberg Live in Singapore. “Debt to GDP is go­ing up rather than down,” he said. “Cer­tain pock­ets of the econ­omy have been forced to bring lever­age down, but in gen­eral this is a story of debt growth.”

Trou­ble is more likely to come from some com­bi­na­tion of cap­i­tal flight and sud­den with­drawal of ex­ter­nal credit.

WANG ZHAO/AFP PHOTO FILES

A Chi­nese worker is seen in Bei­jing’s cen­tral busi­ness dis­trict. China’s econ­omy is de­fy­ing pre­dic­tions of a debt cri­sis or hous­ing bust as it launches a credit clam­p­down.

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