Effects Of Chinas Failure To Reform

By Web Desk
The surge in trading on Chinas commodity exchanges is the latest example of speculative
frenzy in an economy awash with credit. From the rise of shadow banking, to real estate
bubbles and August stock market crash, regulators have struggled to contain the excesses
resulting from Beijings habit of supporting growth through debt-fuelled stimulus. The
rush into metals markets follows record credit expansion of more than Rmb6tn in the first
quarter, engineered by officials to prevent a sharp slowdown in the worlds second-largest
economy.
Such episodes are a growing concern for international investors. As Chinas role in the global
financial system grows, so too does its ability to trigger turbulence in global markets. However,
it is easy to criticise Beijing for resorting once again to credit creation to pump up growth. It is
less easy to come up with an attractive alternative for policymakers.
The risks of Chinas vast debt pile are apparent. A total debt load equivalent to some 240 per cent
of gross domestic product - far higher than most emerging markets - is clearly unsustainable in
the long term, especially since a significant proportion is held by loss making state-owned
enterprises in sectors suffering from chronic overcapacity. Even more worrying is the speed at
which debt has accumulated - with credit creation accelerating even as economic growth has
slowed.
Yet investors clearly find these risks less frightening than an imminent prospect of the economy
crashing and the currency plunging - the fears that sent global markets into a tailspin at the start
of the year. Beijings actions since January have cast doubt on its commitment to difficult

economic reforms, but they have also helped to stabilise the exchange rate and led to a welcome
pick-up in industrial profits.
Moreover, the risk of a full-blown financial crisis seems limited. Chinas overall debt level is less
alarming in the context of the countrys largely closed capital account, its high savings rate which means that households finance lending to corporates - and the economys growth
potential. There is also considerable scope for the government to shift corporate debts (which in
practice often relate to state-owned companies or local government) on to its own balance sheet,
which remains robust, backed by still-vast official reserves.
However, this will merely defer the problem, albeit for some years, unless China comes up with
a comprehensive plan to tackle the corporate sectors bad debts. As the International Monetary
Fund has warned, the governments current proposals for financial restructuring of nonperforming loans (through debt-for-equity swaps and securitisation) will be insufficient, and
possibly counterproductive, unless it also tackles the underlying need for industrial restructuring,
including in politically sensitive sectors.
Rebalancing Chinas economy is a Herculean task and it is almost inevitable that stimulus
policies will continue for the foreseeable future as authorities try to manage the process. What is
important is to ensure that this is more profitably employed. The authorities reflex has too often
been to prop up zombie companies in sectors dogged by overcapacity, with effects on industrial
rivals across the world. Yet investment is still needed in health, education, urban housing and
transport, and an enormous environmental clean-up. In the most benign scenario, it will still take
the best part of a decade to reduce Chinas debt burden to a more sustainable level. In the
meantime, the rest of the world can expect to feel the effects of Chinas failure to reform and
rebalance its economy earlier.