The IMF concluded its Financial Sector Stability Assessment with China, saying this week that China’s policies could give rise to financial stability risks.
“Pressures to keep non-viable firms open – rather than allowing them to fail – are strong,” a release on the IMFs website said. “As a result, the credit needed to generate additional GDP growth has led to a substantial credit expansion resulting in high corporate debt and household indebtedness rising at a fast pace.”
Indeed, even China’s central bank chief sounded the alarm several months ago, when he warned of a “Minsky Moment.”
But, despite the continued debt growth, corporate profits have been rising even faster. As Bloomberg reports Wednesday, supply cuts, rebounding prices and a boom in global trade have boosted profits and put China’s companies in better shape to cope with regulators’ efforts to reign in leverage.
“Profitability conditions have improved a lot, not only for the state-owned companies but also the small and mid-cap companies,” Margaret Yang, an analyst at CMC Markets Singapore was quoted as saying. “This will give policy makers more room to push through the deleveraging campaign and keep monetary policy neutral.”
Chen Zhao argued at the Financial Times on Monday that debt-to-GDP ratio – a gauge used by the IMF in its findings – has proven to be misleading:
Looking around the world, the levels of interest rates for different countries are negatively correlated with levels of total indebtedness. Countries that have borrowed aggressively — such as Japan, China and Singapore — have very low or zero interest rates. On the other hand, countries that have barely borrowed, including Brazil, Russia and Indonesia, usually pay very high interest rates. This negative correlation is highly significant, disproving the widely held notion that higher debt levels lead to higher risk premia at the macro level.
The problem, Chen says, is the ratio only provides a narrow snapshot of an economy’s debt picture.
Whether or not China’s debt poses a great risk to domestic or global financial stability aside, a slowdown in growth is still in the cards, say some.
Michael Pettis, a finance professor at Peking University said Thursday that he has “absolutely no doubt” that growth rates are going to be “much, much lower” once Beijing gets control of credit growth. 2% to 3% lower, in fact, he told CNBC.
Accomplishing that goal, however, might be slow going.
“The question is,” Pettis asked, “which is the sector that can absorb the cost with the least damage to the economy?” The answer: local governments.
“There are the so-called vested interests. They are politically quite powerful so the process of forcing them to absorb the cost of the debt has been very difficult.”