Red flags are waved enthusiastically in Beijing as a matter of course. But one red flag which likely won’t be so welcomed is this month’s warning from the Bank for International Settlements (BIS), the clearing house for central banks.
Parts of its latest quarterly review have added to concerns that the Chinese economy could be heading for a credit crunch.
The main warning from the BIS is based on the ‘credit-to-GDP gap’, which tracks how much a nation’s banks are lending compared to the size of a country’s economy. If the banks are going gangbusters on loans and the economy isn’t growing at the same pace, the gap widens.
The BIS says that two-thirds of all countries with a gap of 10% or more have suffered serious banking strains in the three years that follow. Currently, China’s gap is more than three times the danger point at 30.1%, the highest since 1995. This is larger than the gap experienced in the US before the banking crisis and it is approaching the even higher levels of countries like Thailand and Ireland before they were laid low by credit crunches of their own.
Thailand and Ireland may not be the best comparators for a country of China’s size and complexity. Indeed while the BIS gives its warning for countries bleeping the alarm at or above the 10% level, China has been stuck above that for much of the last seven years, with no financial implosion.
China’s total debt is a lower percentage of its GDP than the average for advanced economies, and much lower than countries like Japan. But analysts say that the rate at which debt is accumulating is alarming, up from 147% of the economy at the end of 2008 to 255% in March this year.
Much of the early surge in lending was welcomed around the world as Beijing turned on the credit taps in the wake of the global financial crisis. Since then, however, the authorities have struggled to curtail fresh flows of credit.
For instance, bank lending lurched ahead again in the summer, more than doubling in August from July, with many of the new loans heading to homeowners. In fact, Chinese lenders have been lending more to homebuyers and real estate firms than at any time since 2008.
Then again, another countervailing view is that the Chinese will stave off financial crisis because they don’t have much foreign currency debt. Plus a significant proportion of loans are being granted by state-owned banks to state-owned companies, making it harder to predict how a financial collapse might proceed.
“But even if this risk is mitigated in a system where government bureaucrats can order banks and borrowers just to roll over bad debt, there remains the problem of growth stagnation as an ever-larger portion of new loans are used to pay off old ones,” an editorial in the Financial Times warned this week.
Sections of the Chinese leadership share similar fears, it seems, including the mysterious “authoritative figure” that headlined the People’s Daily in May with warnings that China had to stop using bursts of credit to bolster its economy. Boosting growth with surges in lending was like “growing a tree in the air”, the unnamed person suggested (see WiC325).
The peculiarity of China’s political system means that statements such as these need to be made in a coded way. But international concerns about the health of its financial system are being communicated more directly. The BIS report comes after a similar warning from the IMF earlier this summer, which focused on corporate debt levels, estimating that Chinese firms owing as much as $1.3 trillion weren’t earning enough to meet interest payments.
Outstanding loans had reached $28 trillion, the IMF claimed, as much as the commercial banking systems of the US and Japan combined. The fear is that potential losses in the corporate sector could take a calamitous chunk out of Chinese growth.
Well, we have been warned…
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