China debt mountain weighs on global financial stability
September 12 2017 11:45 PM

Communist China has stepped in to champion the cause of globalisation and free trade in the face of US President Donald Trump’s policies of protectionism and inward-looking isolation. But systemic risks in the world’s second largest economy make it the biggest threat to global financial stability, according to a QNB report.
Government-led stimulus has been a key driver of China’s economic growth since late 2008. Along with that, the country has also built up a mountain of debt at nearly 300% of gross domestic product (GDP) compared with around 140% before the global financial crisis.
Driven by low interest rates, the major driver of China’s credit growth has been household debt, expanding by an average of 19% a year since 2011. At this pace, it could more than double the current level and potentially be 70% of GDP by 2020 versus 30% in 2013.
The banking sector has ballooned, too, with wealth management products tripling to $3.8tn as they offer higher yields. The rapid unwinding of trades funded with margin debt fuelled the $5tn equity market slump in 2015.
The trillion dollar Belt and Road (also known as Silk Road) plan, the centrepiece of a soft-power push by President Xi Jinping, also raises fears. More than $250bn in China’s overseas investments failed between 2005 and 2015, according to the China Global Investment Tracker, a database maintained by the American Enterprise Institute and the Heritage Foundation.
Chin’s slowing growth has raised concerns that years of risky lending could lead to a disaster worse than the US sub-prime collapse. Growth fell to 6.9% in 2015, the weakest pace since 1990. The economy expanded 6.7% in 2016, within the government’s expectations, though the pace was the slowest in a quarter of a century. Moody’s expects growth to slow to around 5% in coming years, saying the economy will, however, remain robust and the likelihood of a hard landing is slim.
But looking beyond the negative headlines, one encouraging fact stands out: China’s biggest companies are healthier than they’ve been in years. The market capitalisation-weighted average debt-to-equity ratio at China’s 100 biggest non-financial businesses dropped to 68% at the end of last year from 72% in 2015, according to Bloomberg data. Profit margins and interest coverage ratios also improved, while free cash flows for the group swelled to a record $93bn.
In August, foreign exchange reserves rose nearly $11bn to $3.092tn, the highest level since October last year.
The improvements could help ease fears of a looming financial crisis in China, even though smaller Chinese companies have made less progress so far.
A Chinese financial crisis, which doesn’t look imminent, will be a massive shock to the global economy, says QNB. The debt challenge is much bigger; the economy’s outsized role in global trade means a contagion would spread to the global economy rapidly, while China’s compliance with post-crisis financial regulation is poorer compared with the US and Europe.
How China’s $10tn-plus economy fares is no longer an internal issue, but one with dire consequences across the world.

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