Markets & Economy
China: Danger ahead?
July 18, 2014
Catherine Gordon: The stability of China's banking system continues to be a concern. Alexis Gray, an economist in Vanguard's Australian headquarters joins us to give her analysis. Alexis, how serious is the debt problem in China right now?
Alexis Gray: Well, the main concerns about debt in China are firstly that debt levels have been growing very rapidly since the global financial crisis. The other concern is that a lot of loans have now been extended through the shadow banking system, which is more loosely regulated. We tend to see shadow banks extending loans to borrowers who are less creditworthy and more likely to default on those loans. So, shadow banking poses a bit of a risk to the financial system. Chinese authorities have been tightening regulation on shadow banks and trying to rein in credit growth, and they've had some early success. So, we've seen credit growth cooling off over the last 18 months.
It's possible that we could see a credit crisis in China although I would place a very low probability on that scenario. It's certainly not our central forecast. There are some important differences, in fact, between China today and the situation in the United States back in 2008. What we see in China is that the banking system is still relatively healthy. Most loans are funded domestically rather than offshore, so China is not exposed to a significant extent to currency movements or offshore interest rate movements.
The other important difference between China and the U.S. is that most lending in China is intermediated through state-owned banks. So, if the financial system was ever under pressure, Chinese authorities could simply order those state-owned banks to continue lending, unlike in the U.S. where we saw the banking system temporarily freeze up. So, a credit crisis I don't think is likely to occur. If the risks associated with credit growth are not addressed, though, over the medium term, China is at risk of a sharp slowdown in economic activity.
Catherine Gordon: Chinese officials have been talking about reforming the country's financial system. How can they do so without disrupting their economy?
Alexis Gray: Well, China now is pressing ahead with financial market reforms, which are likely to introduce risks. So, what we'll see I think is market forces playing a greater role in the Chinese financial system, so greater volatility, and financial institutions will be more exposed than they have been in the past. So, it's going to be important for regulation to be introduced to address these risks.
On the flip side, I think that if China weren't to pursue financial market reforms, it would pose a greater risk to the economy in fact because what we see at the moment is some distortion with pricing mechanisms in China, particularly with the level of interest rates and the exchange rate. And this has led to some fairly significant economic imbalances where China tends to overinvest and under-consume. And so if these risks are not addressed, then we could see the imbalances widening further and we could see a sharp slowdown in China. So, we would view the financial market reforms as broadly positive for China and in fact a crucial step towards becoming a developed economy.
Catherine Gordon: Alexis, looking at the near term, how is the Chinese economy performing this year and how might that affect other economies?
Alexis Gray: Well, I think that China's likely to grow at a 7% or 8% growth rate again this year, although this is notably lower than the trend that we saw over the past several decades with double-digit growth rates. There are some risks building in China this year, in particular around very fast credit growth, and some early signs that there may be a property market slowdown. So, there is a risk that we could see a hard landing in China, which would have significant implications for the globe, most notably for China's largest Asian trading partners, but also the commodity exporters like Australia or Latin America. The effects on the United States, I think, would be a little bit more indirect and would fade back through emerging markets.
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A Vanguard economist discusses China's economy
In a short video, economist Alexis Gray evaluates the health of China's economy/financial situation as the central government tries to implement reforms.
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- All investing is subject to risk, including the possible loss of the money you invest.