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China's Economic Transformation Boosts Credit Outlook


  • 2017 provides a good example of how China might be able to sustain growth while executing on reforms.
  • Recent regulation has effectively slowed down credit growth and curbed the shadow banking activities that pose the biggest threat to financial stability.
  • Credit conditions improved in 2017, with fewer bond defaults reported and more upgrades than downgrades (10:1) reported for local government finance vehicles.
  • A look into the mechanism, size and severity of risk from shadow banking in China suggests manageable risks that are being dealt with rather than deteriorating conditions and imminent collapse.

By Jean Yu, CFA

With a growth model heavily reliant on investment in recent years, China’s risks for a hard landing (a rapid fall in growth leading to a recession) are well known. For U.S. investors, much is at stake. China is one of the most important earnings growth drivers for many multinational companies owned by U.S. investors, and it accounts for about a third of global GDP growth. A weaker China would reduce global aggregate demand significantly and hurt many of its trading partners. Accounting for more than 50% of the utilization of many commodity categories, China is especially important for commodity producers, many of which are emerging markets countries like Brazil. As a result, a hard landing in China represents a key global tail risk that might trigger a global recession.

We see a confluence of positive forces that tell us the risk of a hard landing has decreased somewhat, due to lower risk of a credit event in China. This lower risk of a credit event stems from:

1. Better internal and external growth — highlighted by China’s party congress as “quality growth” — involving more consumption and an increased role for the private sector.

2. Effective regulation aimed at the shadow banking activities.

Better Growth Via Less Investment, More Consumer

One of the biggest concerns for China is that to carry out its reform agenda it will have to endure a period of depressed growth. This is because large parts of the structural reform, such as restructuring state-owned enterprises (SOE), cleaning up bad debts and financial deleveraging, generally hurt growth. However, 2017 provides a good example of how China might be able to sustain growth while executing on reforms, albeit with some help from a stronger global economy. Better internal and external growth should allow China to address structural reform, including financial deleveraging and excess capacity

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Comments (6)

Aricool profile picture
also, China's working age population has already begun to plummet the past 2 years and is accelerating, which will also kill consumption growth and spending/debt capacity. because China makes it near impossible for common people to immigrate and become citizens, there is nothing China can do about that unintended blunder of the one-child policy. this will force China to use more and more financial shell games and ever surging debt to hide the fact that the Emperor (Xi) wears no cloths...


China’s total working-age population, or the number of people aged between 15 and 64, was 998.3 million people last year, compared to 1.0026 billion at the end of 2016, data from the National Bureau of Statistics showed, the biggest decline since the working-age population began falling in 2014.

The number of people 65 or older meanwhile increased to 11.4 percent of China’s population of 1.39 billion people, up from 10.8 percent in 2016.
Aricool profile picture
author is drinking the China Koolaid and spoon-fed canned data.

re "Credit conditions improved in 2017, with fewer bond defaults reported and more upgrades than downgrades (10:1) reported for local government finance vehicles."

it is well known that in China companies get loans to keep paying prior loans, and China gov does not permit any bankruptcies. So, the author talking about China default rates at all makes me chuckle.

Re “ household debt, though low, is rising, and is more and more connected with asset-price speculation”

Is the author looking at 2+ year old data? Consumer debt has soared in China and now well exceeds 50%. How is 50% of of GDP “low”? and to say ‘rising’ is an major understatement. It is tripling past rates and amounts.

Re “China has been reducing its reliance on investment-driven growth for some time: fixed asset investment has gradually declined to 7% year over year increase in the most recent quarter (Exhibit 1). Meanwhile, consumption, a more sustainable source of growth, plays an increasingly large role — it is already two thirds of China’s total GDP growth (Exhibit 2)”

That is another funny one b/c the gov just shifted debt driven FAI in the SOE’s and social spending to consumer debt driven consumption growth which is pure lost money b/c unlike FAI, consumption purchases are largely depreciating non-producing assets. China is doing in 10 years what it took the US 150 years to do, but US per capita wealth had long prior already attained high wealth status, whereas China is still a poor country on per capita basis; thus, this debt driven growth time bomb all but guarantees China will be stuck in the middle income trap like Brasil, which is much worse off than Japan or S. Korea who escaped it.

the pace of growth for household debt is worrying. Between January and October last year, according to recent data from Southwestern University of Finance and Economics, Chinese household leverage rose more than eight percentage points, from 44.8 percent to 53.2 percent of GDP -- a record increase.
By contrast, between 2009 and 2015, households had added an average of just three percentage points to their debt-to-GDP ratio each year, and that includes a large jump of 5.5 percentage points in 2009 as banks ramped up lending in response to the global financial crisis. Before 2009, household debt levels had hovered around 18 percent of GDP for five years. In other words, the debt burden for Chinese consumers has nearly tripled in the past decade

Most worryingly, though, skyrocketing home prices seem to be driving much of the increase in household debt. Higher mortgage rates -- and, especially, government policy-- have compounded the problem. In order to slow rising prices, officials have raised down-payment requirements, pushed banks to slow mortgage lending, and placed administrative restraints on purchases. That’s led buyers to borrow from different, often more expensive, channels. Online peer-to-peer lenders, for instance, who charge much higher rates than banks, have become popular sources for borrowing cash for down payments.

Despite these efforts, households are still in the mood to borrow, as the lending data from January show. That’s the first and most vexing consequence of the government’s well-meaning efforts to boost consumption: Once the debt genie is out of the bottle, it’s very difficult to squeeze back in. If China’s households continue borrowing at their current pace, it would take only four or five years before their debt-to-GDP ratio reaches the same level as in the U.S. just before the 2008 crash.
Many good points in the well written article. I am just little more optimistic on the housing "bubble" risk.
Housing bubble in China? We have heard of that for at least 15 years and yet prices have gone up by 300% to 500% or even more in those 15 years in most big cities from a very low base. If the government allow purchase of a second house for investment/rental purposes without any mortgage/ownership registration limitations, like in most other countries, prices will shoot up further before reaching a temporary peak and start falling like it did in 1993-1996 when they fell more than 50%. The 1992 price level in Shanghai was reached again only in 1997/1998 when the government introduced a temporary mortgage interest deductability from personal income. The Chinese housing market is far away from that "if". Another reason for prices to drop would be if interest rates increase, say about 50% or 300 basis points for mortgage rates. They are also still quite far from that happening. We may not see Chinese mortgage rates at over 12% like in 1993 at least in the next five years. Where is the housing bubble?
Ben Gee profile picture
Maybe China is not going to collapse after all.
Aricool profile picture
China can choose between collapse within 5 years or decades of no growth. It was wise, at least at this late point, it seems that Emperor Xi is choosing the later path. And his recent crowning as Emperor will be needed for him to tighten the iron fist on the social decent that low or no growth will create in the rural areas.
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