China's credit boom threatens global financial stability

China's credit boom threatens global financial stability
  • China has made rapid development, but a debt-bomb is ticking in its backyard!

China has begun a war on its pile of corporate debts amounting to $18 trillion. On October 10 the government launched a scheme to ease the loan burden of its state-owned companies. This scheme permits firms with lighter debt-load to convert their bank debt into equity. However, only healthy firms with long-term growth prospects are allowed to make use of this scheme.

Even so, financial experts have a different view. They say that debt-to-equity plan may not solve the present crisis as it is akin to swapping a bad debt with a bad equity. On top of it, the guidelines do not put restrictions on companies from seeking further loans. Mergers, acquisitions and bankruptcies have also been introduced as tools for corporate debt-fighting. Furthermore, state companies that do not make profit may get fresh capital.

Looming crisis

China's debt is largely state-owned. Despite the country's impressive growth, its debt is estimated to be around 230 per cent of its Gross Domestic Product (GDP). The state-controlled banks are heavily debt-laden. The Bank for International Settlements (BIS) has recently forewarned the country’s banks to resolve the debt-crisis before it is too late—China has only three years to save them from sinking, BIS said.

Corporate sector bad loans pose the greatest threat to the banks’ survival. China has the highest ratio of corporate debt-to-GDP—currently at around 170 per cent.

On the other hand, China’s household debts are assumed to be generally risk-free and stay well within global limits. In the past, lending firms have liberally encouraged state-owned companies investing in infrastructure projects. These companies have invested even in merit-less ventures mainly for generating jobs. Two-thirds of the bad loans obtained by state-owned companies belonged to state-controlled banks. While private companies struggled to get their loans approved, state intervention made matters smooth for the public sector companies.

China’s debt is rising, though growth has slowed down. The official auditing agency has warned that its statutory debt limit for 2015 has already been crossed in 2013 with an outstanding debt of 18 trillion yuan ($2.67 trillion). China's massive public and private debts—$25 billion and still growing—pose a serious threat not only to the Chinese economy, but to global economy.

Cleaning up

Debt-fuelled investment in China may explode anytime, and weaning it off the debt-crisis will be costly as it may slow down the economy. Besides a slump in growth rate, the market has to cope with aftershocks owing to greater volatility throughout the cleanup period.

China's challenge is to reverse the current trend—it has to sustain its robust growth rate while keeping a check on the growing debt. The International Monetary Fund expects China to cut down its deficit budget to 3 per cent of its GDP this year. In 2015, the total fiscal deficit was high at 10 per cent. The world’s second biggest economy has the privilege of settling a deal at its own convenience as the both debtor and creditor are under the same government. Nevertheless, it has to act before it goes out of control. 

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Topics : #China | #economy | #banking

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