Year of the Dog reflections: China’s deleveraging push

AsianInvestor looks back on its outlook articles for the Year of the Dog. In this piece, we consider how Beijing prioritised deleveraging to handle its burgeoning debts.
Year of the Dog reflections: China’s deleveraging push

At the beginning of every Chinese New Year, AsianInvestor makes 10 predictions about economic, political and financial developments that are likely to have an impact on the way institutional investors assign their money. And then, one year later, we revisit these forecasts to see how well we did.

Our sixth Year of the Dog forecast focused on whether China's mounting debts would push its economy into difficulties. 

Will China's debt burden become a major drag on its economy? 

Answer: No - correct 

In early 2018, a key concern regarding China was its mounting level of debt. The country had splurged on new loans since the global financial crisis to finance enormous amounts of investment, as it sought to prop up economic growth over the next decade.

That led its total debt to GDP to rise from 171% in the first quarter of 2008 to 299% by the first quarter of 2018 according to the Institute of International Finance; a level well above the average of 175.4% for emerging market economies.

A mounting concern among economists and investors was that this debt burden was causing systemic risks to rise, even as extra debt had less impact on stimulating economic growth. These concerns led President Xi Jinping to declare that his administration would deleverage, but this raised fears that dealing with these debts would lead to a major drag on economic growth.  

These fears were largely ill-founded, as we predicted. China recorded GDP growth of 6.6% for 2018, according to its National Bureau of Statistics. That was lower than the 6.9% it had reported for 2017 ­– indeed, the 2018 figure was the country’s lowest annual growth rate in 28 years – but it didn’t mark a major fall from the 6.9% recorded in 2017.

The limited impact of China's debt burden on GDP was in part down to the country's macroeconomic rebalancing. Whereas it used to rely exclusively on exports and investment to shore up growth, in the years following the global financial crisis, Beijing also encouraged more consumption, allowing salary rises as it sought to stimulate domestic demand.

That helped to cushion China’s economy somewhat, even during the mounting US-China trade war of 2018. In addition, despite the US applying tariffs on some Chinese products, they proved remarkably resilient. The country’s total exports grew by 7.1% across the year and only really showed signs of weakness in December when they grew by just 0.2% year-on-year.

However, China’s debts are not on a downward trajectory, despite the government's efforts. True, the country's non-financial corporate debt hit a record 241.4% of GDP in 2016, according to the Bank of International Settlements, but then stabilised amid the Xi administration’s deleveraging efforts and stood at 241.5% at the end of 2017.

The slowing growth was down in large part to Beijing's efforts to curb shadow banking-related lending and the growth in state-led investment (which is largely debt-financed). However, these efforts proved to be transitory. China's total debts started rising again last year, with non-financial corporate debt jumping to 253.4% in the first quarter, before falling a little to 253.1% in the second (the latest statistic).

Meanwhile, the government's earlier efforts to cut back on leverage began affecting GDP growth. This, combined with the end of year impact on the trade war, helps explain why China reported a lower GDP rate last year.

China's total debt to GDP probably pierced the 300% to GDP level by the end of 2018. and debt-funded investment could well increase further this year. Beijing looks likely to attempt various methods of stimulus to offset the mounting impact of the trade war, and one is likely to be a loosening the spigot on corporate debt funding once more.

Expect to see China’s total debt to GDP ratio rising anew, even as its GDP struggles to remain at its 2018 rate. The country’s debt burdens are here to stay.   

Previous Year of the Dog outlook reflections:

Will the Bank of Japan's quest to create inflation succeed?

Are European and UK stocks a good bet in 2018? 

Will the US Treasury yield curve invert?

Will Donald Trump still be president at the end of 2018?

What will be the best performing mainstream asset class, on a risk-adjusted basis?

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