China’s attempted economic transition has deep implications, not just for the emerging nation, but for the rest of the world. In the short term, the challenge is to manage spillovers from what might be a sharp slowdown in China’s economic activity. In the long term, it is how to cope with the integration of a financial powerhouse into the world economy. In reality, however, what happens in the short term will shape the longer term as well.
India’s latest Economic Survey provides a thought-provoking taxonomy of crises. The external impact of a crisis depends, it argues, on whether it occurs in systemically important countries, it is the result of fiscal or private borrowing and whether currencies of affected countries appreciate or depreciate. What might this analysis have to do with China? The answer is that it is a systemically important country that suffers from high and rapidly rising corporate indebtedness. This might lead to a sudden halt in investment and a rapid depreciation.
Such a sharp slowdown is not at all impossible. The combination of an ultimately unsustainable rise in corporate debt with the dependence of demand on ultra-high rates of investment creates the vulnerability. As the economy slows to growth below 7 per cent a year, investment rates of close to 45 per cent of gross domestic product no longer make economic sense. The private sector is also responsible for close to two-thirds of investment. So market forces might impose a painful adjustment.