Wobble in China has ripple effects

China, and China-centred Asia, is now the centre of the world economy, and steady growth has been a source of stability in an otherwise unsteady world. As a result, even a tiny wobble in the country’s economic performance, such as was visible in the data for May, makes the world sit up and take notice.

The numbers have received even more scrutiny than usual because of the context: both a Chinese stock market that has fallen into bear market territory, and a growing trade dispute with the other great economy, the US.

Despite China’s astonishingly strong and sustained expansion, the economy is widely considered vulnerable because the growth in output has been underwritten by an even faster increase in debt. This has been particularly true since the financial crisis, when the country’s leaders accelerated the building of infrastructure, real estate and other fixed assets with a big increase in debt-fuelled investment. The country’s gross debt, both public and private, is now estimated at more than 250% of GDP.

The worry is not just the volume of debt but its quality, which is hard to assess but is likely very uneven. After years of talking about it, China has begun to slowly tighten the credit taps, with tighter rules on shadow banking and more scrutiny for both local government financing and public-private investment projects. At the same time, a sharp increase in the number of defaults by corporate issuers has revived dormant anxieties about Chinese debt. It is the tighter credit conditions and the defaults, rather than worries about a trade war, that best explain the 22% decline in the Shanghai Composite from its January highs.

Tightening credit policy is also the most compelling explanation for the weak economic numbers for May. Credit growth fell, and growth in fixed asset investment followed. This appears to be having some effect on consumer sentiment as well. However, the fact remains that if China is serious about reducing its economy’s dependence on debt, it must strike a fine balance. London, June 27