China’s economy has slowed in recent years, but it is still going strong and is responsible for about one-third of total economic growth worldwide. It is also becoming more sustainable, in line with the shift in its growth model away from investment and exports and toward domestic demand and services.
In the run-up to next month’s G20 summit in Hangzhou, Beijing has been calling loudly for new commitments to structural reforms to stimulate growth in advanced and emerging market economies. However, China faces serious risks at home. Above all, domestic credit continues to expand at an unsustainable pace, with corporate debt accumulating to dangerous levels.
According to the IMF’s annual report on the Chinese economy, credit is growing about twice as fast as output. It is rising rapidly in both the nonfinancial private sector and in an expanding, interconnected financial sector that remains opaque. In addition, while credit growth is high by international standards — a key indicator of a potential crisis — its ability to spur further growth is diminishing.
Warning signs are flashing and the Chinese government has acknowledged the overall problem. However, to avoid a crisis, it should immediately implement comprehensive reforms to address the root causes of the corporate debt problem. These include soft budget constraints for state-owned enterprises (SOEs) and local governments, implicit and explicit government guarantees of debt; and prevention measures against excessive risk taking in the financial sector.
To tackle the problem, Beijing must, in the words of Chinese Premier Li Keqiang (李克強), “ruthlessly bring down the knife [on] zombie enterprises.”
This culling should be combined with concrete measures to restructure salvageable firms; recognize and allocate creditor losses; account for displaced workers and other social costs: and further open private-sector markets.
It is especially important to restructure SOEs. Many are essentially on life support, contributing only one-fifth of total industrial output but accounting for about half of, all corporate debt. A serious restructuring effort — including stricter budget constraints and an end to lending to nonviable firms and government guarantees on debt, along with other supply-side reforms already underway — would create space for more dynamic companies to emerge and contribute to growth.
China is unique in many respects, but it is not the first country to experience corporate debt difficulties. Its leaders should heed three broad lessons from other countries’ experience.
First, authorities should act quickly and effectively, lest today’s corporate-debt problem become tomorrow’s systemic debt problem.
Second, they should deal with both creditors and debtors — some countries’ solutions address only one or the other, sowing the seeds for future problems.
Finally, the governance structures that permitted the problem to arise must be identified and reformed.
At a minimum, China needs an effective system to deal with insolvency; strict regulation of risk pricing and assessment; and robust accounting, loan-loss provisioning and financial disclosure rules.
Influential voices in China are quick to draw the lesson from international experience that tackling corporate debt can limit short-term growth and impose social costs, such as unemployment. These are valid concerns, but the alternatives — half measures or no reform at all — would only make a bad situation worse.
China should begin by restructuring unviable companies in its fastest-growing regions, where workers would find new jobs more quickly and reforms are not likely to hurt growth. Policymakers can then be more selective when it comes to restructuring in slower-growing regions and cities where a single company dominates the local economy.
In addition, structural unemployment and worker resettlement costs can be mitigated with a strong social safety net that includes funds for targeted labor redeployment so that workers can get back on their feet. This approach would show the government’s commitment to those at risk of displacement.
To its credit, China has already made some efforts to solve its debt problem and begin deleveraging. The current Five-Year Plan aims to reduce excess capacity in the coal and steel sectors, identify and restructure nonviable “zombie” SOEs, and fund programs to support affected workers.
Now is the time for China to push for far-reaching reforms. Banks’ balance sheets still have a relatively low volume of nonperforming loans — and high provisioning. The costs of potential losses on corporate loans — estimated at 7 percent of GDP in the IMF’s latest Global Financial Stability Report — are manageable. Furthermore, the government maintains high buffers: debt is relatively low and foreign-exchange reserves are relatively high.
The question is whether China will manage to deleverage enough before these buffers are exhausted. Given its record of economic success and the government’s strong commitment to an ambitious reform agenda, China can rise to the challenge. However, it must start now.
David Lipton, first deputy managing director at the IMF, was senior director of the US National Economic Council and National Security Council during US President Barack Obama’s first administration.
Copyright: Project Syndicate
Could Asia be on the verge of a new wave of nuclear proliferation? A look back at the early history of the North Atlantic Treaty Organization (NATO), which recently celebrated its 75th anniversary, illuminates some reasons for concern in the Indo-Pacific today. US Secretary of Defense Lloyd Austin recently described NATO as “the most powerful and successful alliance in history,” but the organization’s early years were not without challenges. At its inception, the signing of the North Atlantic Treaty marked a sea change in American strategic thinking. The United States had been intent on withdrawing from Europe in the years following
My wife and I spent the week in the interior of Taiwan where Shuyuan spent her childhood. In that town there is a street that functions as an open farmer’s market. Walk along that street, as Shuyuan did yesterday, and it is next to impossible to come home empty-handed. Some mangoes that looked vaguely like others we had seen around here ended up on our table. Shuyuan told how she had bought them from a little old farmer woman from the countryside who said the mangoes were from a very old tree she had on her property. The big surprise
The issue of China’s overcapacity has drawn greater global attention recently, with US Secretary of the Treasury Janet Yellen urging Beijing to address its excess production in key industries during her visit to China last week. Meanwhile in Brussels, European Commission President Ursula von der Leyen last week said that Europe must have a tough talk with China on its perceived overcapacity and unfair trade practices. The remarks by Yellen and Von der Leyen come as China’s economy is undergoing a painful transition. Beijing is trying to steer the world’s second-largest economy out of a COVID-19 slump, the property crisis and
As former president Ma Ying-jeou (馬英九) wrapped up his visit to the People’s Republic of China, he received his share of attention. Certainly, the trip must be seen within the full context of Ma’s life, that is, his eight-year presidency, the Sunflower movement and his failed Economic Cooperation Framework Agreement, as well as his eight years as Taipei mayor with its posturing, accusations of money laundering, and ups and downs. Through all that, basic questions stand out: “What drives Ma? What is his end game?” Having observed and commented on Ma for decades, it is all ironically reminiscent of former US president Harry