One of China’s leading economists and monetary policy experts asks if China’s heavy-handed deleveraging drive is fully justified, and whether or not it could exacerbate economy’s debt-deflationary spiral.
In an essay published by Project Syndicate, Yu Yongding, who is a former president of the China Society of World Economy as well as a former member of the People’s Bank of China’s Monetary Policy Committee, says that China’s high debt-to-GDP ratio does not pose a “real risk” to China’s financial system for a number of reasons, chief amongst them a high level of gross savings amounting to 48% of GDP, which will help to keep the cost of capital low.
China also has $3 trillion in foreign exchange reserves at hand, an amount well in excess of the country’s foreign debts, which gives Beijing ample means to bail out any ailing banks, while the Chinese central bank has thus far proven more than willing to pour liquidity into the market whenever required.
Yu further notes that the preponderance of Chinese debt is perceived as enjoying an implicit guarantee from the government, given that most lending is by state-owned banks to state-owned enterprises.
A final factor curbing debt risk is the implementation capital controls, which would prevent any exodus of capital in the case of emergency.
For Yu the key area of concern is instead China’s overcapacity-driven debt-deflationary spiral, with the producer-price index posting 54 consecutive months of year-on-year decline, as well as modest consumer-price index stuck at 1.5%.
“There is no doubt that China’s debts – especially its corporate debts – are serious problem and must be curbed,” write Yu. “But China must balance that imperative with the more urgent need to maintain a growth rate more or less in line with potential, and prevent the economy from being tipped back into a debt-deflationary spiral.”
According to Yu the debt-deflationary spiral poses “a more acute threat to China’s economic stability than the risks stemming from debt-to-GDP ratio,” as well as one which might be severely exacerbated by an excessively rapid deleveraging drive.
The former PBOC monetary advisor remains an advocate of economic stimulus via expanded infrastructure investment, on the grounds that “it makes no sense to lower the growth rate…when an economy is growing at roughly its potential rate, as China’s is today,” while it will be difficult to boost consumer spending due Beijing’s ongoing failure to create an adequate social security net.
Yu also points to the potential for fiscal stimulus to serve as an adjunct to financial reforms and productivity gains.
“Such an initiative should also entail improved financing opportunities – including lower borrowing costs – for small and medium-size enterprises,” write Yu. “Meanwhile,the rise in the corporate debt-to-GDP ratio could be stemmed by efforts to improve capital efficiency, boost enterprise profitability, narrow the different between credit flows and credit-finance investment, increase the share of equity finance, and align the real interest rate with the natural interest rate.”