The Strategist

IMF: Debt boom in China can lead to new financial crisis

08/17/2017 - 09:14

China's economic growth is too dependent on credit now, and because of this, the country may suffer from a new financial crisis, the International Monetary Fund fears. The Fund improved the forecast for the growth rates of the second world economy. According to the IMF, China's GDP will grow by 6.7% this year, and will accelerate to 6.4% in the next. The forecast’s previous version assumed an increase of 6.6% and 6.2%, respectively. Accelerating the growth of the world economy and increasing government spending spurred the growth of China's economy. However, as the huge debt bubble grows, risks will increase in the near future.

Mstyslav Chernov
Mstyslav Chernov
Growth in China was supported by a rapid increase in debt in recent years. "Nominal volume of lending to the non-financial sector has more than doubled in the last five years, and the ratio of the country's total debt to GDP in 2016 has increased by about 60 percentage points to 230%," the IMF (quoted by The Telegraph). It is expected that by 2022 the debt-to-GDP ratio will rise to almost 300% of GDP. "Steady growth - growth that would have been possible without excessive credit expansion - would probably be well below actual growth over the past five years," the IMF analysts believe. If the level of debt increased more smoothly, GDP would grow by an average of 5.3% per year in the period from 2012 to 2016, rather than 7.3%, as it was in reality. "International experience shows that the current credit trajectory of China is dangerous, as the risks of destructive correction and/or a noticeable slowdown in growth are increasing," the report says. Analysts of the IMF studied 43 major credit booms, ie, when the ratio of the total debt of organizations to the country's GDP exceeded 100%, and found that almost each of them eventually led to a sharp slowdown in economic growth or a financial crisis. "All credit booms ... ended badly," the report says. This was also due to the fact that the debt was financed at the expense of increasingly "complex and, first of all, short-term financing schemes".

In addition, according to the IMF, huge funds borrowed by Chinese companies were not used efficiently: lending to industrial enterprises, state-owned companies and in some regions increased, but this did not leverage the added value of borrowers. In 2015-16, loans were issued for 20 trillion yuan, but this allowed to increase the nominal GDP of the country by only 5 trillion yuan. The scale of the hypothetical collapse of the economy will be limited, as China has a surplus current account and a low level of external debt; the fact that the ratio of the loan portfolio to deposits in the country's banks is kept at a low level will help mitigate the blow. Among the examples of major crises that occurred despite the fact that the country's economy was strong, the IMF shows the American crisis of the 1980s, the banking crisis in Japan in 1997, and the experience gained by the United States and Britain during the global financial crisis.