By IE&M Research
There is one main point that confirms there is a crisis in China – debt service ratios are 20% higher than the ratio in the US at the onset of the 2007/8 subprime crisis.
China’s corporate debt is large by international standards and greater concern is its concentration in old industries that suffer from overcapacity and weak competitiveness. Although the authorities are taking steps to halt the rise in corporate debt, but this is unlikely to be enough to avert the financial crisis and a prolonged period of slowing growth. The government has announced that it will carry out a debt-for-equity swap for the debt held by its state-owned banks in struggling companies to reduce rising corporate debt, which at 171% of GDP is more than twice as high as that in the US. It is a policy the country used back in 1999 amid rising bad debts. China has certainly entered a danger zone.
The best single early warning indicator of financial crises, Credit-to-GDP gap, is too high for China.This is a serious matter as bad news from China creates turmoil in global financial markets as happened in August last year and January this year. China contributes roughly one-third of global GDP growth, and the IMF estimates that more than a third of equity and FX price moves in advanced countries are driven by news from Chinas.
If we see here the chart of the credit-to-GDP gap in the quarter preceding nine severe banking crises, we find: Norway (1990), Sweden (1991), Finland (1991), Japan (1992), Mexico (1994), UK (2007), US (2007), Ireland (2008), and the Netherlands (2008). In many cases, we find the credit-to-GDP gap exceeded 8 prior to the onset of a severe financial crisis. In fact, it is considered that a credit-to-GDP gap in excess of 8 is the danger zone (BCBS 2010). In China today, the ratio is at 30.
There are three main points that confirms there is a crisis – First, debt service ratios are 20% higher than the ratio in the US at the onset of the 2007/8 subprime crisis; Second, house prices have been rising very strongly, and this increases the exposure of the economy to a sudden drop in real estate prices; Third, a big chunk of credit goes to the old economy, where profitability and cash flows are slowing. The bad debts is almost $0.7 trillion, or 6.5% of China’s GDP. It now needs to act quickly to reduce corporate debt and strengthen bank balance sheets.
