A credit bubble means China could well be heading for a corrective period, according to the latest ICAEW quarterly report. Credit-fuelled investment has created capacity without demand, raising the possibility of a series of defaults. However, savings and reserves mean a full-scale crisis should be averted.
Economic Insight: Greater China is a quarterly report produced by Cebr, ICAEW’s partner and forecaster. Commissioned by ICAEW, it provides a current snapshot of the region’s economic performance for ICAEW Chartered Accountants and other stakeholders.
The report warns that China has an extraordinarily high level of credit for its level of development, partly driven by the growth of the shadow banking sector and banks moving loans off balance sheet into Wealth Management Products (WMPs). This credit has bankrolled a huge expansion in investment, in some cases creating capacity where there is no market demand. The risk is that if no market is found, these loans may go bad. There is even a chance that a series of defaults could create the conditions for a financial crisis. However it is more likely that the credit bubble will be deflated gradually, slowing growth but avoiding a crash.
ICAEW Economic Advisor and Cebr’s Executive Chairman, Douglas McWilliams, said: “China is highly leveraged; there is 8.2 trillion yuan in WMPs alone. As the economy slows it is likely that some of the underlying assets will fail to perform, leaving financial institutions counting the cost. The China Banking Regulatory Commission has taken some initial steps to reduce risk in the WMP market, by capping investments in non-standard assets, banning pooling of assets and requiring banks to isolate the risks of such investment vehicles from other operations, but the risk from bad loans remains a serious concern.”
However, the report notes that the Chinese authorities have the resources to bail out the banks if need be, thanks to a high level of existing savings and foreign currency reserves. Douglas said: “Not only is China’s debt relatively low, but most if it is held domestically – external debt is only around 7.2% of GDP. This gives the Chinese government far more power to deal with any financial difficulties than governments which rely on the support of foreign creditors. Chinese firms and local government have mostly borrowed from the Chinese people. There would undoubtedly be political and social consequences from defaults, but there is no doubt the situation could be resolved.”
James Lee, ICAEW Regional Director Greater China believes that one way forwards is to focus on developing China’s capital markets. James said: “At the moment, the lack of depth in the stock market forces Chinese companies to depend on banks for lending. This means their options are limited, especially if the government restricts the volume of loans. Low returns have also driven investors towards the shadow banking sector. Although China’s stock market is relatively well capitalised, current regulations prevent it from growing more quickly, with the government retaining control over Initial Public Offerings (IPOs). If the government considered relinquishing this control then the market could decide which firms are worth investing in, whilst also providing an alternative way for businesses to seek finance.”
The report can be found here: http://www.icaew.com/en/about-icaew/where-we-are/greater-china/economic-insight-greater-china