Re­form can pre­vent Ja­pan-like debt cri­sis

China Daily (Canada) - - LIFE -

Despite deep­en­ing con­cerns about China’s econ­omy, the coun­try is not head­ing to­ward “lost decades” of Ja­pan-style stag­na­tion. And yet a wor­ri­some am­bi­gu­ity clouds this ver­dict.

China’s non-fi­nan­cial debt has in­creased from 150 per­cent of GDP in 2008 to 255 per­cent to­day, with two-thirds of the in­crease con­cen­trated in the cor­po­rate sec­tor, largely Sta­te­owned en­ter­prises. Since China has the high­est sav­ings rate in the world— its gross do­mes­tic sav­ing av­er­ag­ing 49 per­cent of GDP since 2007— its surg­ing debt hardly comes as a sur­prise. Economies with high sav­ings are prone to high in­vest­ment, and the lack of cap­i­tal mar­ket re­form in China— ex­ac­er­bated by the burst­ing of the equity bub­ble in 2015— re­in­forces the dis­pro­por­tion­ate role that bank credit has played in fund­ing the coun­try’s in­vest­ment boom.

The Ja­pan com­par­i­son is es­pe­cially in­struc­tive in as­sess­ing the risks of debt-in­ten­sive growth. At nearly 390 per­cent of GDP in late 2015, Ja­pan’s over­all debt ra­tio is about 140 per­cent­age points higher than China’s. But be­cause Ja­pan has such a high sav­ings rate— av­er­ag­ing 24 per­cent of GDP since 2007— it ba­si­cally owes its debt to it­self. That means it is not vul­ner­a­ble to the cap­i­tal flight of for­eign in­vestors that of­ten trig­gers crises.

With China’s sav­ings rate dou­ble that of Ja­pan’s since 2007, that con­clu­sion is all the more per­ti­nent for its debt-in­ten­sive econ­omy. The China scare of early 2016— stoked by hand-wring­ing over cap­i­tal flight and cur­rency risk— missed this point al­to­gether. Fears of a hard land­ing stem­ming from a Chi­nese debt cri­sis are vastly overblown.

Zom­bie com­pa­nies— the eco­nomic walk­ing dead— are also a topic of in­tense dis­cus­sion in China. Key ac­tors in Ja­pan’s first lost decade in the 1990s, zom­bie cor­po­ra­tions were kept alive by the “ev­er­green­ing” of sub­si­dized bank lend­ing — mask­ing an out­size build-up of non-per­form­ing loans (NPLs) that ul­ti­mately brought down the Ja­panese bank­ing sys­tem. Sig­nif­i­cantly, the in­sid­i­ous in­ter­play be­tween zom­bie cor­po­ra­tions and zom­bie banks clogged the ar­ter­ies of the real econ­omy— lead­ing to a sharp slow­down in pro­duc­tiv­ity growth that Ja­pan has yet to re­verse. In re­cent pub­lic state­ments, the Chi­nese lead­er­ship has made ex­plicit ref­er­ence to zom­bie SOEs. And, un­like Ja­pan, which re­mained in de­nial over this prob­lem for close to a decade, the Chi­nese au­thor­i­ties have moved rel­a­tively quickly to rein in ex­cesses in two key in­dus­tries— steel and coal — while hint­ing of more to come in ce­ment, glass and ship­build­ing. China’s de­te­ri­o­rat­ing loan qual­ity is also rem­i­nis­cent of Ja­pan’s ex­pe­ri­ence. The of­fi­cial NPL ra­tio of 1.7 per­cent for listed banks is only the tip of the ice­berg. Be­neath the sur­face are “spe­cial men­tion loans”— where bor­row­ers are in the early stages of re­pay­ment dif­fi­cul­ties— along with bad cred­its in the shadow bank­ing sec­tor, both of which could raise China’s ful­ly­loaded NPL ra­tio to about 8 per­cent. In that case, the au­thor­i­ties will even­tu­ally need to in­ject cap­i­tal into the Chi­nese bank­ing sys­tem.

None of this is a dark se­cret in Bei­jing. On the con­trary, an in­ter­viewin ear­lyMay with an “au­thor­i­ta­tive insider”, pub­lished in China’s flag­ship of­fi­cial news­pa­per, Peo­ple’s Daily, un­der­scored an in­creas­ingly open and in­tense de­bate over how to avoid end­ing up like Ja­pan. The insider high­lighted the in­sid­i­ous con­nec­tion be­tween China’s debt and zom­bie prob­lems that might well cul­mi­nate in a Ja­pan-like “L-shaped” endgame.

This gets to the heart of the China-Ja­pan com­par­i­son. Two and a half lost decades (and count­ing) is sim­ply an un­ac­cept­able out­come for China. But know­ing what it doesn’t want is not enough to guar­an­tee that China won’t fall into a Ja­panstyle trap of its own.

Re­forms are the de­ci­sive dif­fer­en­ti­at­ing fac­tor. Ja­pan’s fail­ure to embrace struc­tural re­forms was a hall­mark of the 1990s, and it is an equally se­ri­ous im­ped­i­ment to the cur­rent “Abe­nomics” re­cov­ery pro­gram. By con­trast, China’s strat­egy em­pha­sizes the heavy lift­ing of struc­tural change and re­bal­anc­ing. In the end, suc­cess or fail­ure will hinge on the will­ing­ness of the Chi­nese lead­er­ship to con­front the pow­er­ful vested in­ter­ests re­sist­ing re­form.

The au­thor, a fac­ulty mem­ber at Yale Univer­sity and for­mer chair­man ofMor­gan Stan­ley Asia, is the au­thor of Un­bal­anced: The Code­pen­dency of Amer­ica and China. Project Syn­di­cate

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