Is China’s debt sustainable
THE Chinese government has accelerated the pace of its policy loosening in recent weeks as a policy-induced credit crunch threatens growth and financial stability, and an escalating Sino- US tariff war adds to the headwinds.
Both the Politburo meeting , chaired by President Xi Jinping, and State Council meeting , hosted by Premier Li Keqiang, urged “more expansionary fiscal policy” to boost domestic demand and stabilise the economy.
At the Politburo meeting President Xi said China must “coordinate efforts and policies” to stabilise six areas – employment, finance, foreign trade, foreign investment, investment, and expectations.
Just before this clearer policy tone was set by top leaders, the central bank and financial regulators had stepped up its monetary loosening and regulatory fine-turning in mid- July, albeit still largely in a targeted fashion, in our view.
On the other hand, we note that until early July, the government, particularly the financial regulators and the Ministry of Finance, has displayed reasonable determination in carrying out the deleveraging campaign, with continued emphasis on the need to exit ‘zombie’ companies and tolerate defaults, as well as hinting at the possibility of lowering the GDP growth target.
To be sure, the latest Politburo meeting also reiterated the need to “resolutely maintain its deleveraging drive while better man- aging its pace and intensity” and “better balance its financial risk prevention and boost support of the real economy”.
Although we reckoned that the government is now prioritising stability over its medium-term deleveraging agenda, we believae those statements should dispel doubts about a possible reversal or abandonment of the deleveraging goal.
As the Chinese government once again faces the delicate balancing act between “stabilising expectations and growth” in the short term and “structural reform and risk prevention” in the medium term, the question arises of what happens next? In this respect, we think it is useful to understand how China got to where it is now and assess the state of the markets and the economy.
We’ve described China’s deleveraging plan and its priorities, what actions have been undertaken and for what purpose, and the channels through which the various deleveraging measures have affected the financial system, financial markets, money and credit growth, and the economy.
While Vice Premier Liu He and his team appear to share the IMF/ BIS diagnosis that a high leverage and credit-fuel growth model leads to an unsustainable build-up of debt, and former People’s Bank of China Governor Zhou warned of a ‘ Minsky moment’ in October 2017 as deleveraging has not necessarily meant ‘debt reduction’ in China.
Debt/GDP has been widely used by financial regulators to evaluate the economy-wide leverage, but the government has not set specific targets for macrolevel leverage.
Only for the central SOEs, a debt-reduction target was set in January 2018, calling for two percentage points reduction in leverage ( liability/asset ratio) by 2020.