- Debt in China is rising and non performing loans are rising. But no crisis is imminent. Only bank profits will suffer.
- Acquisitions spree explains much of the rise in debt. But there is no sign of widespread overleveraging, which is often the prelude to crises.
- Double digit growth in outbound tourists is still continuing, witnessing a relatively strong Chinese economy.
In the 1980s I had the occasion to follow a group led by Prof. Byron Weng, a political science professor from the Chinese University of Hong Kong, to visit various research organizations in America. Among those we visited was the Brookings Institution, and there we met Nicholas Lardy. Nicholas Lardy at the time was pessimistic about China’s banks. Today, however, he is upbeat. In an article last year in New York Times he chided those who sounded “False Alarm on a Crisis in China”, which many keep repeating and keep being proven wrong each time. He wrote:
Naysayers question government economic data, continuing to focus on weakness in China’s industrial sector and the extremely slow growth of electric power output. But steel production, for example, is significantly more energy intensive than entertainment, so the demand for electricity has fallen sharply as the structure of the economy has evolved.
He pointed to strong consumption growth and disposable income as evidence the economy is humming along. He also said that while debt has grown quickly it is not a big concern.
It is true that debt in China is rising very fast, and China’s banks are witnessing a rise in non-performing loans. But while this is a problem hurting banks’ profits it is not a problem that will kill the economic growth. As a sign of China’s economic health, its outbound tourists growth is still very impressive. An article in Forbes magazine, published on December 30 2015, noted that:
China’s outbound tourism …registered double that growth rate (by which he meant 8%) for each of the last three years, confirming the resilience of the demand for travel beyond the borders of mainland China in an impressive way.
The article also pointed to the strong spending of Chinese tourists, which certainly backs up the narrative of rising household incomes.
If all is well, why then is debt rising, and why then is NPL rising? Much of the explanation, in my view, has to do with Chinese companies taking advantage of low borrowing costs to engage in an acquisition spree. An article in May this year in Wall Street Journal reported:
Chinese firms have struck $110.8 billion in overseas deals this year, according to Dealogic. To put that number into context, not only is it already a full-year record – surpassing 2015’s $106.8 billion – it is more than triple 2014’s year-to-date total, the previous high through this point in the year.
These deals in part explain the depreciation of the RMB, because RMB needs to be sold in order to get the foreign money to buy foreign companies.
This shopping spree of course has little to do with the rise in NPL, which is largely due to two things. One is the demise of SOEs in traditional heavy industry which is suffering from a huge excess capacity problem. The other is the demise of small and medium export-oriented companies which are suffering because of poor export markets.
These problems, as I explained, only bogged down banks’ profits but are not sufficient to create a financial crisis, which typically needs widespread excessive leveraging as was the case in the U.S. and Europe prior to the Global Financial Tsunami. China does not have a serious overleveraging problem.
The Chinese economy is on a restructuring path that will benefit the environment, and that will address the regional disparity problem. I agree with many of the recommendations of the IMF, which advised higher healthcare spending and more redistribution as well as deregulating the service sector. However China is already doing this, and indeed more rapidly than is expected by most observers. The IMF also advised moving toward a floating RMB. That is an advice that I do not share, however.
I have been arguing all along that floating or pegging is really not the issue. The issue is overvaluation or undervaluation of the currency, which can occur with both floating or with the peg. A floating Yen had broken the Japanese economy till Abe tried to fix the problem with the help of Kuroda at the Bank of Japan. A pegged Argentine peso had broken the Argentine economy prior to 2002.
China still has many problems. But it is not due for a hard landing.