China has embarked on an economic balancing act that is bound to appear counter-intuitive to many observers. Trying to trim the country’s ballooning debt burden without sacrificing rapid growth sounds akin to keeping a horse running fast while feeding it less hay. There is always a danger that the horse may stumble and fall, causing the earth to shake.
Any sign of flagging economic dynamism in China will therefore be met with concern. Every year, the Chinese economy adds more to global output than any other. As a result, a flurry of less than vibrant economic statistics raises an insistent question: is China’s credit squeeze finally morphing into a credit crunch?
Deflation, as measured by the producer price index (PPI), deepened to -4.6 per cent in April. Industrial profits fell 2.7 per cent in the first quarter and land sales, a key source of revenue for cash-strapped local governments, by almost a third year on year.
The main concern is that falling industrial profits could render companies less able to service their huge debts, prompting them to call off or postpone investment plans and driving an upsurge in non-performing loans that would dissuade banks from lending. Indeed, fixed-asset investment growth is already declining significantly: falling to 12 per cent in the January to April period.
Such strains are exacerbated by another factor. Although Beijing has loosened monetary policy three times over the past six months, real interest rates are rising sharply as deflation bites. They climbed to 10.8 per cent in March, their highest level since the financial crisis. Nominal average lending rates are lower, at 6.6 per cent, but still anomalously high in a world in which some $2tn in bonds trade at negative yields.
The impact of such a tight credit environment becomes clear when the size of China’s total corporate debt service burden is calculated. Given that non-financial total corporate debt is estimated by McKinsey to amount to $12.5tn, Chinese companies are paying on a nominal basis some $812bn in interest payments each year. In real terms, this amounts to $1.35tn. This is not only significantly more than China’s projected total industrial profits this year; it is slightly bigger than the size of a large emerging economy such as Mexico.
Beijing has several policy options at its disposal to keep a full-blown credit crunch at bay. Most analysts expect China to keep cutting interest rates while seeking to alleviate deflation by kick-starting infrastructure projects and invigorating the property sector. There are signs that such efforts are starting to bear fruit.
A more long-term approach involves relieving the debt mountains that have piled up on the books of local governments, which are the main agents of infrastructure investments. In March, the finance ministry said it would allow local governments to refinance Rmb1tn in off-balance-sheet debt as official government debt by selling bonds to state banks. Banks initially gave the plan a less than enthusiastic reception, but Beijing has reinforced its support by ordering that banks keep up lending to infrastructure projects that are ongoing.
The situation that China faces is an unenviable one. But amid all the pressure, Beijing’s policy makers are adopting the right priorities. Forced to choose between deleveraging and maintaining a rapid clip of gross domestic product growth, they have opted for the latter. A credit crunch would risk an economic crisis from which it might take years to recover.
