Will China Survive its Mounting Credit Risk?
With Beijing tightening credit, it is a reminder for stock markets across the globe, about the Trillions of Dollars of losses in market capitalisations, back in 2015. Rising lending rates, and the sound impact on reflationary trade across the globe is what investors fear. While China was able to avoid a very problematic point in its financial history in 2008, the same may not happen now with its spiraling credit. Their spirited campaign to manage all the spending by the government to escape the crisis has now come back to haunt them. The debts incurred to avoid the crisis are just too huge. In other words, China has just postponed a crisis, now whose signs are so visible with some serious concerns. This goes to mean that China is likely to have a financial crisis, which, if not well managed, may lead the economy to perhaps the worst financial tribulation which may have an impact for many years to come. The question is, what is the cause of this mounting credit risk?
One of the biggest challenges of China is its internal credit. In such a scenario, capital outflows call for the central bank to sell its foreign reserves to avoid the weakening Yuan. This would mean that the monetary policy would be tightened, creating a vicious circle because such problems will bring about further cash outflows.
The private businesses in China are in deep debt, having borrowed to pay the loans they had borrowed earlier on, both brought about by over-investments, as well as the slow economic growth, on a fiscal stimulus campaign. The problem was not the help, but the recipients of the help. The goal was to invigorate the economy with the betterment of such sectors, so that they could withstand competition from new entrants. But, somehow, the strategy backfired, leaving he economy hungry for more.
In as much as credit can help deal with current defaults, lack of productive investments signals a collapse of the economy in a few years to come. With easy money, it was hard to drive the economy upwards since productive investments are lacking. With the government having a great control on the economy, it can balance the debt levels, and manage the credit risk. It can increase the fortunes of the economy by improving and heightening the demand of service industries since currently, it may not be prudent to go the recession way. But whether this happens or not, may be the answer as to whether the crisis can be addressed well or not.
Tougher measures around the weakest State Owned Enterprises (SOEs) – including liquidation – can be a good consideration. To achieve this, there has to be a sound and sustainable framework for bankruptcy management which is easily understood by all markets.
Increasing competition can also improve the efficiency of lending – particularly if banks are incentivized to lend to more innovative private sector firms. Access of private banks in the finance sector can significantly reduce SOEs corporate debt. Preferential tax treatment which can help businesses to manage their debt can be a good measure.
Instead of reducing the debt-to-GDP ratio, which can deny businesses that need debt to grow a chance to do so, hence an economic slowdown, managing debt can be a good way to deal with this. A good move is the move by China to reduce corporate debt. Offsetting the domestic asset bubbles by transferring debt to asset management companies and stabilizing foreign exchange reserves are among the options available. Interestingly, a recession in China can give room to catapult the economy and ensure that businesses which do not add value to the economy are done away with.