While China's economy is showing positive signs of momentum, potential dangers – from the growth of credit expansion to investment – loom on the horizon, says Manu Bhaskaran
This article was first published in the May 2017 China edition of Accounting and Business magazine.
China’s economy has responded so well to the government’s stimulus measures that a burst of short-term optimism is likely to draw investors back to Chinese assets.
Factories are churning out goods at a more vigorous pace, services activity is gaining momentum, investment has revived, exports are growing and retail sales remain strong. Better still, China is no longer on the brink of deflation. But, on investigation, concerns are emerging.
The first is the massive expansion in credit. Total social financing, a term encompassing the many forms that bypass government regulations, is soaring. The total burden of all kinds of debt stood at around 270% of GDP at the end of 2016, up from around 250% in 2015. Total debt has quadrupled since 2007, with much of the growth coming from the corporate sector. As a result, some of the metrics used by the Bank for International Settlements to determine the chances of a financial crisis are beginning to flash red. In particular, the ‘credit-to-GDP gap’, which measures the differential between the debt-to-GDP ratio and its long-run trend, is estimated to be about 30 percentage points: extremely high by any measure. Some analysts estimate that companies’ interest payments are now approaching 10% of GDP – at a time of relatively low rates.
Another worry is the growing risks in the smaller banks that have been expanding total assets at a pace that is double or even triple that of the top commercial banks. These smaller institutions are also resorting to less reliable sources, such as the inter-bank market and the so-called wealth management products; both can be fickle, especially should there be some financial stress. Wealth management products now account for close to 40% of GDP, from a negligible level just six years ago, having grown six times since 2011.
A third concern is that too much of the economic revival is owed to the real estate sector. Home prices are rising again in most Chinese cities. Indicators of the sector’s future prospects – such as land purchased by developers – point to further expansion. However, fearing that another bubble is brewing, policymakers have started imposing restrictive measures on home purchases and mortgages.
A fourth concern relates to the still-heavy dependence on investment to fuel growth. Investment accounts for around 47% of GDP, an astoundingly high figure. But the large amount of excess capacity and declining profitability are dampening spirits. Were it not for government-driven infrastructure spending, state enterprise-led expansion of favoured industries, euphoric levels of investment in exciting technologies and the revival in real estate investment, a fall in investment could have tipped the Chinese economy into recession. But, as the real estate sector heats up and inflation rises, policymakers have to cut back on stimulus.
A final concern is over long-term policy. Some fear that the shift to an industrial policy favouring local champions could compromise the flow of foreign technology and capital that has been crucial to China’s development – or it could provoke retaliation from trading partners.
The good news is that policymakers are fully aware of the risks and are stepping up regulatory measures. Over the last decade, when the economy faced a series of challengers, astute and timely policy action has helped China avoid a crisis. This is one reason why financial markets remain relatively cool about the risks.
Could this confidence be misplaced? The most likely scenario remains one of episodic stresses which policymakers are able to manage, rather than a full-blown crisis.
Manu Bhaskaran is CEO of Centennial Asia Advisors in Singapore