China must reduce its debt levels before financial markets lose faith in its ability to prevent a macroeconomic shock to the domestic and global economy, bankers and analysts have warned.
Financial market participants said the fear factor was rising as trade tensions made it increasingly hard for China to manage a delicate balancing act between hitting its growth and deleveraging targets.
Piyush Gupta, CEO of DBS Group, told GlobalMarkets that “pumping liquidity into the system will prop the economy up over the short-term, but is likely to have negative consequences over the medium term”.
China’s corporate leverage is what worries him the most. “It’s a systemic risk to the global economy, far more than the trade war with the US,” he said.
According to the Institute of International Finance, China’s gross debt to GDP ratio has risen from 171% to 299% over the past decade, much of it thanks to surging corporate debt.
Brian Coulton, chief economist at Fitch Ratings, said China had made progress in reducing its credit growth rate but that most of the recent drop had been thanks to its shadow banking clampdown.
“But the overall debt stock hasn’t dropped,” he noted. “China still has the policy tools to stop this causing a GDP shock. But if debt to GDP starts to rise rapidly again, then financial markets will turn more sceptical about the government’s commitment to deleveraging.”
He said that if and when China resumed the deleveraging campaign in earnest, it would knock 1% of GDP growth for two to three years. Gupta also said it was about to translate into real pain for creditors.
“Debt restructuring will be one of 2019’s key themes,” he said. “Debt holders will be impacted right across the credit spectrum from government-owned to private sector debt.
“The government’s attitude towards state-owned steel companies has already shown it’s willing to let creditors take a hit if it feels it’s necessary,” he said. “Implicit state support cannot be taken for granted.”
The government is now countering the economic impact of rising tariffs by easing off its deleveraging campaign. On Sunday, for example, the People’s Bank of China cut banks’ reserve requirement ratio by 100bp.
However, not everyone is worried. Wei Christianson, Morgan Stanley’s co-CEO for Asia Pacific, said the government was not sacrificing its policy agenda to protect growth.
“Financial clean-up has remained in focus, though likely with a slower pace of implementation,” she told GlobalMarkets. “China has completed more than 60% and it’s been smoother than expected, with only a limited impact to the real economy.
“China’s credit boom has been a key factor driving economic growth over the past decade, but it won’t be a bubble that bursts,” she said.
Christianson highlighted the fact that that banks provided 75% of all domestic credit and that broad credit growth had moderated from a 16% peak (year-on-year) in April 2016 to 11.7% currently.