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China able to steer clear of debt crisis
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AFTER reviewing the recent developments around the debt issue, we have not changed our view that China can still avoid a systematic crisis in the near term, as the issue remains largely a domestic problem and in the state sector.
The composition of China’s debt issues is largely within the country, unlike typical cases in emerging markets. Its external balance sheet still looks relatively resilient as China continues to run current account surpluses. China has also been building up net foreign assets over the last decade, and is one of the largest net lenders in the world and domestic savings remain high enough to fund investments.
In addition, the situation in the domestic markets still looks manageable. In fact, the borrowers have been largely in the state sector, directly or indirectly, through various government entities or state-owned enterprises. The lenders are also mainly state-linked, with banks (state dominant) making loans, holding bonds or channelling a big part of shadow activities.
The People’s Bank of China has prepared plenty of tools to avoid a liquidity squeeze, with capital controls still relatively effective, at least with respect to short-term flows.
Ultimately, the government has enough resources to bail out the banking sector or major SOEs if necessary to prevent systemic risks.
The private sector does not appear to present big concerns, at least for now. In particular, following a major property correction since 2013, the health of the sector looks to be improving, although there is still a long way to go in smaller cities. Households have been leveraging up, but their debt levels are still relatively low with saving rates remaining high.
We are not too concerned about the existing troubled debt, as there are possible solutions to clean it up while avoiding a systemic crisis, and the implementation process has already started. The more challenging issue is how to prevent the generation of new bad debt.
A first step in this direction is to improve the efficiency of resource allocation. Ongoing financial reforms, including the liberalization of interest rates, bond markets, IPOs, private banking, a more flexible foreign exchange regime as well as the opening of onshore interbank markets over the last couple of years are positive attempts.
Continued efforts to shift toward a more market-driven monetary policy transmission mechanism is also helping. The anti-corruption campaign has also effectively enhanced relatively better supervision of the state sector. That said, SOE reforms have been relatively slow, with mixed signals, although we see certain positive developments, such as individual defaults allowed and a pledge to remove their public functions.
(Qinwei Wang is an economist at Pioneer Investments)
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