A senior economist at UBS says that China is continuing to amass debt at a rapid clip despite its much-vaunted deleveraging campaign, but that policymakers are well positioned to avoid meltdown.
Speaking to Fairfax UBS China economist Donna Kwok said that policymakers “have no intention” of tamping down overall levels of economic leverage given the threat this could pose to growth.
“What’s more important? Making sure that growth remains stable, or addressing this need to lower the debt-to-GDP ratio at a cost of destabilising growth?”
Kwok’s remarks would appears to be sharply at odds with repeated comments made by both government officials and state media on the need to forge ahead with the deleveraging campaign launched towards the second half of last year, in order to defuse with the exorbitant volume of debt accrued since the Great Financial Crisis.
UBS estimates China’s debt to be around 280% of GDP, which would put it ahead of both the US and European Union.
According to Kwok the deleveraging campaign is instead intended to reduce the pace of credit expansion, as opposed to reduce the level of debt across the real economy – an opinion also espoused by former Fitch Ratings analyst and much-feted Chinese banking expert Charlene Chu.
Regulators are especially intent upon reducing the scale of the shadow banking sector, given its exorbitant size and the risk intrinsic to its unregulated character.
UBS estimates that the shadow banking sector accounts for 30% of total system credit in China, while a recent report from the China Banking Association indicates that the shadow banking activities of banks are equal to nearly 110% of their on-balance sheet assets.
According to Kwok regulators have focused in particular upon reducing the “layering effect” created by the interbank transactions that are considered a key part of Chinese shadow banking, and involve large banks lending to smaller banks who in turn channel the funds to their final destinations.
This layering effect not only increases the cost of capital for end users, it also makes it difficult for both regulators and banks themselves to accurately determine how funds are being used, as well as associated risks.
“Right now a lot of the supervisory and regulatory tightening is geared towards pushing for financial deleveraging and the unwinding of these types of layers,” said Kwok.
According to Kwok the uncertainty and opacity of this layered credit poses a major risk for the financial system, as its lacks provisioning as well as checks and balances, making it more difficult to ascertain problem areas and provide remedy measures such as liquidity injections in the event of crisis.
While China’s deleveraging campaign may be somewhat disingenuous, Kwok remains confident that its economy is still capable of accumulating debt without incurring disaster.
She points to a slew of “unique factors” that reduce the likelihood of a debt-induced crisis, chief amongst them fact that the biggest banks in China are state-owned, as are their largest clients, who are typically state-owned enterprises.
This means policymakers wield strong influence over both the debtors and creditors to loans within the financial system.
In addition to this 95% of credit is sourced from domestic sources – primarily the banks which continue to dominate the Chinese financial system, as opposed to overseas lenders. Banks also have ample access to capital given China’s high domestic savings rate.
A final factor favouring the ability of policymakers to prevent China debt from turning into disaster is its heavy capital controls, which would forestall any large-scale exodus of funds that might damage the economy.