Written by Dan Steinbock
Despite seemingly mixed messages, China’s great shift from easing to tightening has begun. While growth will continue to decelerate, it can still remain on the deceleration track, even as deleveraging has begun.
In May, Moody’s Investor Service downgraded China’s credit rating. But it took less than a day for Chinese financial markets to recover from the downgrade. Recently, index giant MSCI announced the partial inclusion of China-traded A-shares in the MSCI Emerging Market Index. After all, China is currently under-represented in global equity indices relative to its economic influence. The inclusion is predicated on a long and gradual move.
In brief, Moody’s believes that the rapid rise of Chinese debt has potential to degrade its future prospects, while MSCI thinks that China’s future is grossly under-valued. One focuses on the cyclical story; the other on the secular potential.
There is a reason for seemingly mixed messages: Like more advanced economies, China has now a debt challenge. Yet, the context is different and so are the implications.
The debt difference
In 2015, US total debt (private non-financial debt plus government debt) exceeded 251 percent of the economy. Except for Germany (166%), the comparable figures in other major European economies are reminiscent of those in the US, including UK (249%), France (278%), and Italy (253%). In Japan, total debt exceeds a whopping 415 percent of GDP. In China, it was 221 percent but it has grown very rapidly.
The numbers illustrate the stakes, but not the story. In advanced economies, total debt has accrued in the past half a century, decades following industrialization. After rapid acceleration amid industrialization and the move to post-industrial society, their growth has decelerated, along with excessive debt burden in the postwar era.
In advanced economies, debt is a secular burden; in China, it is cyclical side-effect.
The advanced economies’ debt is the result of high living standards that are no longer fueled by catch-up growth and are not adequately backed up by productivity, innovation and growth. So living standards are sustained with leverage.
In China, total debt accrued in the past decade, amid industrialization. Unlike advanced economies, different regions in China are still coping with different degrees of industrialization. As the urbanization rate is around 56 percent, intensive urbanization will continue another decade or two.
Due to differences in economic development, Chinese living standards remain significantly lower relative to advanced economies. Yet, rising living standards, which the central government hopes to double in 2010-20, are fueled by catch-up growth and supported by productivity, innovation, and growth.
In advanced economies, debt is a secular burden; in China, it is cyclical side-effect. In both, left unmanaged, it has potential to undermine future.
Deleveraging has begun
For years, policymakers have advocated tougher measures against leverage, which have been expected to follow the 19th National Congress of the Communist Party in the fall. The big news is that deleveraging has already begun. Concurrently, global pressures have increased with US Federal Reserve’s rate hikes.
In late 2016, POBC adopted a tighter monetary stance and has increased tightening in the ongoing year. In May, according to Reuters, total social financing fell to $156 billion from $200 billion, much more than analysts expected. As the decline was driven by non-bank financing, broad M2 money supply expanded by less than 10 percent on a year-to-year basis, the weakest pace in two decades.
For now, policymakers’ deleveraging is on track, as long as it does not downgrade the growth target. In China, it is a medium-term project. In advanced economies, deleveraging is likely to take far longer. But they will not succeed without structural reforms - just as China is already executing reforms to rebalance the economy toward consumption and innovation.
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