Commentary on Political Economy

Sunday 30 December 2018


China’s bid to rein in surging levels of corporate debt has taken a back seat to propping up short-term growth, as trade tensions with the U.S. fuel investors’ fears over Beijing’s commitment to deleveraging the world’s No. 2 economy.
Officials say cutting debt at domestic companies—in particular at bloated state-owned enterprises—is a national priority required to shore up long-term economic and financial health.
In practice, faced with annual growth targets and ongoing U.S. trade tensions that could sap lucrative exports, leaders including President Xi Jinping have stressed shoring up domestic demand and urged local governments to speed up investment projects to ensure adequate growth.
Ratio of China's credit to economic growth
Sources: Sally Chen and Joong Shik Kang, IMF
.trillion yuanChange in credit, ChinaChange in GDP2004’05’06’07’08’09’10’11’12’13’14’15’
Instead of raising interest rates—which some economists say is necessary for China to ultimately succeed in deleveraging—China’s central bank has freed up more cash for its banks to lend. It cut banks’ reserve requirements four times in 2018, freeing up several hundred billion dollars for lending.
“If they were really serious about deleveraging they would have to tighten monetary policy, which is something they don’t really seem willing to do,” said Maximilian Kärnfelt, an economic analyst at the Mercator Institute for China Studies in Berlin.
Total credit to non-financial corporations, percent of GDPSource: Bank for International Settlements
%ChinaU.S.G20 (aggregate)2012’13’14’15’16’17’1860708090100110120130140150160170
China’s central-bank governor Yi Gang defended China’s stance in December, saying “relatively loose” monetary policy is required to stabilize the economy in a downward cycle.
Easy credit to state-owned companies helped propel China’s economic boom, particularly after the global financial crisis prompted authorities to pump half a trillion dollars of stimulus to keep the economy moving. Between 2008 and 2016, total credit to nonfinancial companies grew from less than 95% of gross domestic product to more than 150%, according to the Bank for International Settlements.
Average current ratio by sector, ChinaSource: WSJ analysis of Wind Information data
.timesSteelAutomobilesReal estateClothing andtextilesRetail trade2012’13’14’15’16’
Amid tightening regulations on risky lending, that figure declined to about 147% at the end of 2017 before rising in the first half of 2018, according to the latest data. G-20 countries, by comparison, stood at about 94% of GDP at the end of last year. China’s total social financing—a broad measure of credit that also includes nonbank debt—continued to grow in 2018, although more slowly.
Year-to-date index performanceSource: SIXAs of Dec. 28
%ShanghaiCompositeS&P 500Jan. ’18MarchMayJulySept.Nov.-30-25-20-15-10-5051015
“The commitment of China’s government to controlling and heading off financial risk is still there,” said Dominik Peschel, an economist at the Asian Development Bank in Beijing. Among the positive signals were efforts to cut excess capacity in bloated sectors as a way to improve corporate profitability and reduce debt loads, he said.
By some measures, corporate health in China has improved. Solvency ratios increased at listed companies across a number of sectors, including automobiles and steel, according to data provider Wind Information Co. Profits at companies owned by the central government also grew at a double-digit rate.
Total social financing, ChinaSource: Maximilian Kärnfelt
% of GDP2013’14’15’16’170255075100125150175200225
But U.S. trade tensions complicate matters going into 2019. While the two sides agreed to a temporary truce in December, many economists see a longer-term solution as tougher to achieve—and a source of great uncertainty for China’s growth going forward.  Partly as a result, U.S. and Chinese stock markets diverged in 2018—the Shanghai Composite Index fell around 25% year-to-date versus a roughly 7% decline for the S&P 500.
While economists say China can delay deleveraging in the near term, eventually tackling the buildup of debt in its financial system is inevitable. When it does, the effects could ricochet globally.
Fitch Ratings said in June that deleveraging could cause China’s economy to grow by one percentage point less than its base case. The effects on China’s emerging-market trading partners would be similar, Fitch said, forecasting that growth in Brazil, Russia, South Korea and South Africa could all be around one percentage point lower by 2022 if China moves ahead on cutting debt. Brent crude prices could be about 10% lower, Fitch said.
Percentage point difference between 2020 projection and baselineSource: Fitch Ratings
IndiaMexicoTurkeyPolandIndonesiaBrazilSouth AfricaRussiaSouth Korea-1.2-1-0.8-0.6-0.4-0.20
Stomaching the effects of slower growth could prove difficult for China, where maintaining high employment remains a priority for the Communist Party.
“As of now, it certainly looks like regulation is taking effect, slowing credit growth, but not conclusively reversing anything,” said Mr. Kärnfelt.

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