China has seen a prolonged credit boom since the global financial crisis. But policymakers only last year began to root out the uncertainties associated with debt-fueled investment. Whereas President Xi Jinping’s first term saw growth being prioritized, his second term is clamping down on the build-up of excessive risk.
Johanna Chua, chief Asia economist at Citigroup, argues that significant progress has been made in many areas to fend off financial risk, with the Party rolling out pragmatic policies to address the nation’s deluge of debt. In this interview, she gives a scorecard on this year’s round of deleveraging.
Maurits Elen: Has China effectively deleveraged this year?
Johanna Chua: We need to first define what “deleveraging” means. China does not want to reduce the overall credit to the real economy given the significantly adverse impact it would have on growth and employment. However, three things have happened since last year when financial deleveraging policies came into greater focus.
First, the credit-to-GDP ratio or measured as aggregate financing stock to GDP ratio has stabilized, alleviating risks related to the continued sharp rise in the aggregate leverage ratio.
Second, there was a notable redistribution of debt composition towards the household sector where leverage in the latter is lower, and alongside high household savings and significant home equity, posed less of a solvency risk.
Third, the growth of “intra-financial” leverage had slowed sharply last year amid tighter scrutiny on interbank funding, wealth management products, and off-balance-sheet activities of the banks.
In 2018, we have seen the continuation of a stable ratio of credit to the real economy relative to GDP, and the composition of leverage between households and corporates seems to have also stabilized, aided by tighter measures to curb mortgage loans that have slowed household lending growth. The one area of “deleveraging” which has progressed further this year is the outright decline in off-balance-sheet lending in favor of traditional bank loans. Moreover, the implementation of new asset management rules is reducing the financing channels for highly leveraged companies and continues to lead to a widening credit spread differentiation in the onshore market.
At present, can one speak of a clear deleveraging strategy? A report by the IMF in 2016 concluded China had no comprehensive plan yet.
I do not think this is a fair assessment for 2018. China is pursuing a pragmatic approach to financial deleveraging, trying to reduce inherent vulnerabilities from less regulated financial activities that face potential liquidity, credit, and maturity mismatch risks — a welcome development, in our view. It is also trying to fine-tune policies, including the use of various monetary and liquidity tools, so as not to excessively tighten funding conditions as it pursues its regulatory tightening. It has also complemented these financial regulatory policies with attempts to curb excess capacity and facilitate financial market liberalization to open up external sources of financing. However, one glaring gap in the reform progress is the restructuring of state-owned enterprises (SOEs), including hardening their budget constraints and boosting their productivity. This remains an important challenge, because SOE debt accounts for 65 percent of China’s corporate debt.
What sector is most affected?
Financial deleveraging efforts put more pressure on banks to reduce their non-standard credit assets and corporate bond holdings, which in turn are financial channels that are more heavily relied upon by property developers and local government financing vehicles (LGFVs), compared to other sectors. As such, this sector faces more pressure.
If China did not have a massive credit boom following the global financial crisis, would we have seen a hard landing of the Chinese economy?
I think we would have certainly seen a much more pronounced slowdown in China, but given China’s less trade-dependent economic structure and policy room to support domestic demand even without an outsized credit boom, other economies would have fared worse. The credit boom in China was a “gift” to the rest of the world that provided a significant buffer from the collapse of growth in advanced economies and helped lift “animal spirits” during a period of financial panic. This was particularly supportive of emerging markets that had better balance sheets and fundamentals going into the global financial crisis — Asia primarily via the significant positive trade spillovers from Chinese and global growth; non-Asia emerging markets via the sharp rebound in commodity prices. Both experienced supportive capital flows due to a boost to global risk appetite.
The challenge is that many emerging market economies did not use this opportunity of favorable post-crisis growth conditions fueled by China to pursue structural reforms that would have put their economies on a more sustainable growth path. Thus, as the growth impetus from China wanes and if China were to experience a more pronounced slowdown due to drags from its previous credit excess, there may be less global growth support elsewhere.
This interview has been edited for clarity.