The International Monetary Fund (IMF) has criticised China’s ‘dangerous’ credit boom, which has seen the country’s total debt quadruple to £22tn since the financial crisis.
In its annual health check, the IMF advocated that China should seize opportunities to “accelerate needed reforms and focus more on the quality and sustainability of growth.”
China, which is the world’s second largest economy, set an ambitious aim to double the size of its economy in the decade to 2020 – pursuing a growth strategy fuelled by credit.
Its extraordinary credit bubble, however, is placing the country at risk of a financial crisis. The IMF forecasts that China’s debt as a proportion of gross domestic product (GDP) will grow from 235% to nearly 300% by 2022, having previously estimated it would peak at 270%.
The organisation further warned that sustainable economic growth – achieved without excessive credit expansion – was likely considerably lower than actual growth over the past five years. According to its estimates, had credit growth been at a sustainable rate, then GDP would have increased by an average of 5.3% annually between 2012 to 2016, instead of the 7.3% achieved.
Its report stated: “International experience suggests that China’s credit growth is on a dangerous trajectory, with increasing risks of a disruptive adjustment and/or a marked growth slowdown”.
In recent years, China’s gargantuan economy has accounted for more than half the increase in global GDP. Up until the financial crisis, the country depended on Western consumers to take on more debt and purchase goods from its growing export business. However, the post-financial crisis recession saw this demand decrease significantly. To prevent an economic slowdown and mass unemployment if its factories were to close, the government flooded its economy with credit, creating public infrastructure programmes and encouraging banks to lend to speculative property developers.
The credit bubble, however, is looking increasingly precarious. The IMF’s analysis shows that debt has become a less effective form of economic stimulus, with China requiring three times as much credit in 2016 to fuel the same level of growth it achieved in 2008.
The IMF is concerned that China’s vast volumes of private and public debt will hamper the authorities’ ability to respond to a financial crisis. To position itself more strongly, the organisation has recommended that the country focuses on a commitment to reforms and sustainable growth, rather than “precise numerical growth targets”.
It also voiced concern about the country’s banking sector – which is now one of the largest in the world, stating:
“[Its] sharp growth in recent years reflects both a rise in credit to the real economy and intra-financial sector claims. The increase in size, complexity and interconnectedness of these exposures have resulted in sharply rising risks.”
Aware of its credit risks, China has instituted some reforms in recent years, including tighter credit conditions and local government efforts to cool the overheated property market, particularly in cities. However, far more reform is needed to reduce the credit boom and achieve slower growth. What’s crucial, though, is that it is done smoothly in order to protect domestic and international economic stability – avoiding what’s known as a ‘hard landing’.
Although the IMF acknowledges that China’s current account surplus is a mitigating risk factor, leaving it less dependent on foreign borrowing and less susceptible to a sudden drop in confidence, other risk factors remain a concern. A surplus of zombie companies, unsecured loans, an overheated housing market, low-quality stimulus, poorly used debt and an unstable trade relationship with the US have created vulnerabilities. And while contagion to global financial markets will be dampened by the country’s state ownership of banks and existing capital controls, the global impact of a Chinese financial crisis would still be drastic.
In other words, if China sneezes, the world will catch a cold.