Even though China’s most recent data has shown signs of stabilization (and the current turmoil in the Chinese market will likely provide more Chinese policy stimulus via further over-investment, which could perpetuate this capex bubble in the short term) the world is still paying close attention to the gradual unwinding of the country’s historically unprecedented investment ratio of around 45% to GDP. That ratio (down from a peak of 55%) suggests that China is poised to embark on a powerful accelerator-multiplier dynamic to the downside. Add to that ongoing dollar strength, which has inflicted further deflationary pressures on resource producers, most particularly those who have borrowed dollars against declining resource revenues, all of which has put pressure on commodity prices.
Is this the domino that can bring down the global economy? What is the nature of the debt? How much is private? Public? How much of it is foreign denominated (a germane consideration, considering the recent weakening of the Chinese currency)? As Professor Yan Liang, a professor of economics at Willamette University, has noted in her research on the country, China’s growth model has relied on credit driven, investment led growth in the past decades. Its double-digit growth record has been nothing but impressive. However, this growth model has encountered mounting difficulties and China today is wresting with a vexing problem with debt. A high level debt, coupled with declining quality of debt, has rendered the private sector vulnerable; and yet, aggressive deleveraging could further decelerate the economy, producing a vicious “credit spiral”.
So what are the numbers? According to Professor Liang, China’s debt to GDP ratio has reached 217% of GDP (or 281% of GDP, if financial sector debt is included) in mid-2014, up from 134% in 2007. This level is rather unprecedented despite China’s long tradition of credit driven growth. Since China’s market reform in the 1980s, State Owned Commercial Banks, the backbone of China’s financial system, have lent generously to State Owned Enterprises (SOEs) to finance the latter’s fixed asset investment. Credit extension helped mobilize resources and facilitate China’s industrialization and urbanization, whereby engendering a Keynesian-Schumpeterian credit-investment-growth cycle. But this model has gradually run out of steam, as it causes debt accumulation, puts a heavy toll on natural resources and generates rising supply glut in recent years. Chinese policy makers have realized the limitation of the growth model and called for rebalancing, shifting demand from credit driven investment and export to consumption. However, the rebalancing plan did not effectively bring about a reduction of debt; rather, leverage heightens and debt continues to accumulate. In the interview below, Professor Liang discusses the challenges facing China and the prospects of managing a challenging “soft landing” that doesn’t engender a major global economic calamity.