China’s Balancing Act

Hong Kong, 4th July 2017.

In a recent, well-written article, Chinese economist Yu Yongding takes a look at the challenges facing Chinese policymakers. He starts with a subject which has concerned me for some time: the alarmingly fast increase in the amount of debt taken on by Chinese companies. In other countries, such a big debt increase would be a major concern, but Yu sees current levels as manageable thanks to the high savings rate in China which ensures that the banks are funded with stable deposits and so less likely to suffer a liquidity crisis.

Indeed, Yu thinks that a greater concern is deflation. If corporate debt levels were cut then it would mean an economy growing below potential, and with huge overcapacity in the industrial sector and an already negative PPI, growing below potential would usher in a period of serious deflation. In other countries, this could be offset by lower rates or, in extremis, QE, but in China that would risk another dangerous property bubble. So this tightrope walk, balancing debt and growth, is the path China must take.

For all the good points that Yu raises I cannot find myself agreeing with him entirely. The run-up in corporate debt may be manageable for now, but the rate of increase has been high ever since 2009 and if it continues at the same pace, it will at some stage reach a level which even China with its high savings rate cannot cope with. There are other ways of stimulating the economy to keep growth on trend besides cutting interest rates. For example: a weaker currency to help the export and tourism sectors; faster migration to the more productive cities by relaxing the hukou rules; and boosting consumer spending by increasing the social safety net and removing the necessity for large private savings.

China’s challenge is not just a case of balancing debt and growth on a tightrope with disaster on both sides. It is more like the challenge of keeping a bullet train on the tracks, and Chinese policymakers have several levers they can pull to keep the economy from going off the rails.