Does China need a recession?

IMF’s latest warning bell on corporate debt in China requires a look into uncomfortable policy options for deleveraging the economy.

 

The huge injections of liquidity into the global financial system after the financial crisis have resulted in debt levels, which are even higher than pre-crisis times. While China’s debt-to GDP ratio is nowhere close to that of USA’s and the economy still retains one of the highest growth rates in the world, the IMF in its latest report on China has still warned that the country’s  debt risk was soaring to very dangerous levels. Under the dual pressure of over-capacity (read over-investment) in industry and slowing economic growth, Chinese companies are simply borrowing to pay back previous debts and banks are under pressure to lend money to such companies to be able to maintain acceptable rates of GDP growth. However, many economists have red flagged these moves suggesting that Chinese policymakers needed to curb credit growth in weakly performing sectors of the economy and facilitate market entry.

Given the levels of corporate debt, it is possible that curbs on credit might lead to closure of quite a few sick units raising the prospect of a recession. The costs of a recession, defined as “significant decline in economic activity spread over two quarters”, are all too clear- rise in unemployment, stagnant wages, decline in GDPs of countries reliant on China for their exports to name a few. However, economists argue that the choice is not between recession and not recession but between mild recession now and a bigger and more catastrophic recession later. While credit expansion may help to stave off defaults in the present, the lack of new productive investment means greater risks of collapse once the economy is weaned off the easy money. Besides a recession might also help in cutting off excess flab in the economy and carry out timely course-corrections (in China’s case, from industry-led to services-led economy). Japan, whose rates of growth have been low over a couple of decades, is cited as an example of an economy which destabilized its own bank sector through low interest rates which ultimately did not tackle the economy’s vulnerabilities like an over-reliance on exports.

China’s debt levels are still considered manageable. and the high level of public control over the economy gives China’s executive body powers to rebalance the economy in ways that other market-led economies can’t. China’s attempts to “course correct” by stimulating consumer demand and shift to services is also seen to be having effect. Thus, at the moment the case for allowing a recession is still thin in China’s case but will depend on how the country manages its debt appetite.

1 Comment on Does China need a recession?

  1. Demand for goods and services get affected not only based on supply situation but also impacted by consumer psychology during times of peace, war, and large scale natural disasters and calamities.
    Further, how well a country can deal with inflationary or recessionary pressures in the economy, depends upon various factors such as the leverage enjoyed by the country over demand and supply.
    Looking purely at China’s situation as compared to American or European economy, Chinese economy has far greater resilience due its size, exports and domestic demand. Further, it being a Centralised economy, it can interfere in the market easily to bring about a course correction as may deem fit which is not the case with American or European economy. Their economy is still growing at about 7% GDP. Under the circumstances, it may be safely concluded that there are no recessionary clouds howering around Chinese economy.

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