At a July 15 meeting of China’s National Financial Work Conference, with Chinese GDP Growth slowing and the country under criticism for its leverage management practices put on display “a refreshed commitment to vigilance to financial risks and reforms to curb leverage,” a Moody’s report said. The encouragement is a change from analysis earlier in the year from the ratings agency. The positivity of that five-year high-level planning meeting might be spreading, as the International Monetary Fund recently characterized Chinas debt as “moderate,” pointing to reform efforts.
Leverage has been used to fuel historic Chinese GDP Growth
The policy objectives China’s financial leaders envision for the world’s most populous nation exhibited a “wide-ranging commitment to deleveraging, financial stability,” Moody’s noted, with varying credit issues that come into play.
Chinese authorities are now giving an equal weighting to deleveraging and growth even as leverage continues to rise. Growth and leverage have been the elixir that led the nation from near $1.2 trillion (USD) in gross domestic product in 2000 to increase by nearly tenfold, to $11.2 trillion in 2016, vaulting past India’s $2.264 trillion and approaching the US GDP of $18.7 trillion. Chinese GDP growth peaked in 2007 at 14.2% at a time the US, in the middle of a highly leveraged housing boom, only managed 1.8% GDP growth. Chinese GDP growth has since slowed to 6.7%.
“China's growth model has relied on credit-funded investment, especially in infrastructure,” Moody’s noted. China was in part criticized for using leverage to build numerous “ghost cities” that stood idol and bridges that led to nowhere in an effort to spur an economic renaissance.
China’s ascent on the world stage has resulted, with its role in becoming part of the IMF SDR currency basket one of several major milestones. A more recent benchmark may be longtime US ally Saudi Arabia recently announcing that it would be willing to finance its debt using the Chinese yuan, breaking a petrodollar relationship with the US that has been a key strategic objective in the region.
Criticism of China turns to praise
After excessive leverage was used to boost Chinese GDP growth and its trajectory as a world economic powerhouse, concerns began to surface that the Asian nation was overleveraged. Hedge funds engaged in harsh words and began to bet against the leader while the country’s own central bank also was critical of lending practices that were questioned for their sustainability.
Party leadership is addressing those concerns by increasing regulatory oversight of the financial sector and applying a degree of accountability on local government officials for “irregular borrowings” by regional and local governments as well as state-owned enterprises (SOEs).
"The key is to solve the structural challenges and tackle risky issues," said Zhao Qingming, chief economist at the research institute of the China Financial Futures Exchange, who noted the need for economic growth.
But the move to limit risks to financial stability might, itself, cause some risks.
“While the rebalancing of the economy towards consumption has started, credit-funded investment is likely to remain a primary driver of economic growth for the foreseeable future,” Moody’s wrote. “Policy trade-offs will arise between restricting and enhancing the transparency of the supply of credit – whether from shadow banking, the bond market or the formal banking system – while at the same time maintaining GDP growth and avoiding a marked rise in defaults in some sectors.”
It is not a panacea without the risk of unintended consequences. In its report, Moody’s models several quantitative scenarios that point to differing growth projections.
Their baseline assumption is that “credit intensity will continue to rise while credit growth will slow somewhat,” but that will still remain hot on a relative basis to the US, with 6.1% Chinese GDP Growth foreseeable until 2020. “Conversely, further deterioration in credit intensity might occur if reforms are less effective,” with growth projections under this model averaging 5.6% over the next three years.
China’s debt to GDP is reported near the 300% level, a “dangerous” level the IMF was previously quoted as saying. This runs counter to statements made by Alfred Schipke, the IMF's senior resident representative for China.
"China's current public debt level, by our definition, which is a broad definition, is still moderate in an international context," he was quoted as saying.