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China continues to kick the can further down the road

China continues to kick the can further down the road

09-11-2017 | Jaarlijkse vooruitblik
China is doing extremely well, but it’s high economic growth is coming at a price.
  • Léon  Cornelissen
    Léon
    Cornelissen
    Chief Economist

In 2017, the Chinese economy will grow at an unexpectedly high rate of 6.8%, but it has been fueled by a further increase in the debt ratio. The total debt of the non-financial sectors (government, household and corporates) is estimated to have reached a staggering level of about 270% GDP in 2016.

The reasons for allowing China to continue growing for such a long time at such a high rate (too high for its own good) may have been politically motivated, as President Xi Jinping aimed to increase and solidify his power base for the next five years or more in October at the all-important five-yearly Congress of the Communist Party.

The rise in debt is, however, clearly unsustainable and increases the vulnerability of the Chinese economy. On 21 September, the rating agency Standard & Poor’s highlighted this problem, firing a well-timed warning shot by downgrading China’s credit rating for the first time since 1999. These warnings were in line with those uttered earlier by the Bank for International Settlements (BIS) and the International Monetary Fund (IMF).

Investment outlook 2018
Investment outlook 2018

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Sources: Haver analytics and IMF staff estimates

In 2017, the Chinese economy will grow at an unexpectedly high rate of 6.8%. This relatively strong growth has come at a price: it has been fueled by a further increase in the debt ratio. The total debt of the non-financial sectors (government, household and corporates) is estimated to have reached a staggering level of about 270% GDP in 2016. The reasons for allowing China to continue growing for such a long time at such a high rate (too high for its own good) may have been politically motivated, as President Xi Jinping aimed to increase and solidify his power base for the next five years or more in October at the all-important five-yearly Congress of the Communist Party.

The rise in debt is, however, clearly unsustainable and increases the vulnerability of the Chinese economy. On 21 September, the rating agency Standard & Poor’s highlighted this problem, firing a well-timed warning shot by downgrading China’s credit rating for the first time since 1999. These warnings were in line with those uttered earlier by the Bank for International Settlements (BIS) and the International Monetary Fund (IMF).

The question is if Xi Jinping, now firmly in power, will change course and, like a modern Hercules, choose the narrow, difficult path of virtue, full of potholes or, alternatively, the wide, straight and easy path, effectively kicking the can further down the road for a couple of years (if at all possible). Of course, it’s not possible to precisely define the level of debt that would inevitably trigger a crisis, but a long-lasting rapid build-up of leverage will eventually lead to a crash.

Nothing in Xi Jinping’s past suggests he is a reformer, so the IMF is probably right to adjust its growth projections for China upwards in the coming years, while at the same time highlighting the risk of an abrupt slowdown at some point in the future.

For 2018, the upward adjustment of 0.3 of a percentage point to nearly 6.5% mainly reflects the expectation that the authorities will maintain a sufficiently expansionary policy mix, especially through large public investments, to achieve their target of doubling real GDP between 2010 and 2020.

China’s intended rebalancing of economic activity toward services and consumption seems to have slowed. It consequently faces higher debts and therefore diminished fiscal means to address an abrupt slowdown. What could trigger such a slowdown? The IMF has mentioned the possibility of a funding shock, which could take place in the short-term interbank market or in the funding market for wealth management products, for instance, the imposition of trade barriers by trading partners (especially given the unpredictability of the current US administration), or a return of capital outflow pressures now that US interest rates are normalizing.

To be fair, the Chinese authorities are fully aware of the current debt risks, and have recently increased their efforts to curb the expansion of credit. However, if history is any indication, this debt curbing will take a back seat to the all-important growth target. So more can-kicking, which will eventually lead to a bigger crash, seems to be the option of choice.

This article forms part of the Robeco 2018 outlook entitled Playing in Extra Time.

Investment outlook 2018
Investment outlook 2018

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