China is spiralling towards a credit crisis, but it will not be on the same scale as that sparked by the Lehman Brothers collapse in 2008, says Richard Jerram, chief economist at Bank of Singapore.
Despite general optimism after the Third Plenum in November – which mooted measures around price liberalisation, opening up to private and foreign competition, and state-owned enterprise reform – China’s goals are inconsistent, because rebalancing will require dropping wasteful investment being financed by credit expansion, argues Jerram.
The country’s planned transformation from an export-driven economy to one focused on consumption was never going to be smooth, he notes. And even if it is successful, domestic consumption will not be enough to help the country power through a credit crisis.
“That’s pure fantasy,” he says. “China invests too much [internally] compared to Japan or Korea during their growth periods, [and] that’s funded by the credit expansion. That’s always a red flag. There will be a debt crisis, and estimating the size is almost impossible, whether it’s 10%, 20% or 30% of GDP.”
Yet Jerram doesn’t expect a credit crisis in the mainland to have a huge impact on global financial markets. “This won’t be a Lehman-style event. China is not that integrated in[to] the global financial markets, and the government has strong enough finances to buy the bad assets off banks.”
Despite forecasting a speedy “credit explosion” in China, Jerram stressed that fast-growing countries often go through similar growing pains.
“It’s nothing sinister. It’s typical for a rapidly growing emerging market,” he says. “The [original] growth model becomes redundant and it switches to a [consumer-focused economy.] And that will lead to slower growth. It could happen tomorrow or in June. It’s clearly not very far away.”
Also noteworthy is the rebalancing of investment flows across Asia. “Ten years ago, China was the only game in town,” Jerram says. In 2004, for example, foreign direct investment in China stood at $2.5 billion, while investment elsewhere in the region totalled $1.5 billion. The story has since shifted dramatically, with only $3.5 billion invested in China in 2012, compared with $6.5 billion in Asia.
As for Japan, Jerram says the story behind the country’s re-emergence from a two-decade recession is hardly remarkable or surprising. “They went from having the worst monetary policy in the world to a sensible monetary policy.”
He acknowledges that weakening the currency has sent exports up and boosted profits, but remains sceptical about the structural side of the reforms. “I’m positive on Japan, but don’t necessarily believe in Abenomics,” Jerram says. Although business confidence is higher across all sectors and plans for capital investment are improving, wages are still weak.
“It looks unlikely that the Bank of Japan will hit its inflation target of 2% on schedule, and we expect to see pressure for further policy easing around the time of the sale tax increase,” he adds. “Structural reform remains a hope rather than an expectation, and the lack of material progress is cause for concern.”
In the US, meanwhile, the Federal Reserve tapering its quantitative easing programme is unlikely to have a major impact on financial markets, namely because markets have had plenty of opportunity to respond to the shift in policy, suggests Jerram.
Interest rates are unlikely to rise any time soon either, he says, echoing recent comments by Bob Browne, CIO of Northern Trust. “It remains the main weapon for Western governments to minimise the cost of deleveraging,” Jerram notes. “And the US will keep rates at zero as long as possible.” He doesn’t expect upward movement for two-and-a-half years.