Something is somewhat amiss in China. As export markets stuttered in the aftermath of the financial crisis, the country turned to credit to fuel its growth. Total debt owed by Chinese households, companies and governments now stands at almost 200 per cent of gross domestic product, up from 130 per cent in 2008. Much of this has been squandered. In this week’s three-part series, the Financial Times reports vividly on the unused factories, unfinished roads and unlived-in apartments that are the economic detritus left behind by the binge.
Such rapid increases in borrowing usually end in tears. Time and again in emerging economies from Argentina to South Korea, and recently across the developed world, credit booms have spawned an unmanageable load of bad debt, triggering a crisis when creditors eventually took flight. In China, however, this is an unlikely outcome. Stringent capital controls insulate the Chinese financial system. Household savers cannot run, for they have nowhere else to go. The economy’s other large creditor – the Chinese government – controls the country’s currency and owns much of its wealth, including huge foreign exchange reserves. The chance of an uncontrollable financial meltdown seems remote.
Nevertheless, the looming hangover may be painful. China’s economy is highly dependent on credit. This was true even before indebtedness began to spiral in the years following the crisis. Both the official banking sector and informal sources of credit play a large role. Since much of their lending in recent years funded investment that has turned out to be less productive than hoped, much of it can be expected to sour. While there is no threat to the solvency of the financial system taken as a whole, some lenders will struggle, disrupting the supply of credit. This could seriously impede growth. Lenders’ distress must not be allowed to restrict the flow of credit to the real economy, if there are profitable loans to be made.
