Dire warnings about the risks from China’s debt build-up have existed for nearly a decade though the crisis that many expect has yet to arrive.
But with the world’s second-biggest economy growing at its weakest pace since 1990 and US tariffs adding pressure, investors are still nervous.
“Most countries that permit rapid credit expansions face financial crises or a sharp slowdown in the economy as risks in the financial system emerge,” says Logan Wright, director of China markets research at research provider Rhodium Group.
“Many explanations have been put forward as to why this has not happened in China so far, primarily emphasizing economic factors: a high national savings rate and a low level of external debt,” says Mr Wright, who was lead author of a recent in-depth report on China’s financial risks for the Center for Strategic and International Studies, a Washington think-tank.
The dominant role of state-owned institutions as both borrowers and lenders has also contributed to stability since the government can order state financial institutions to provide support to a stressed borrower and avert a default that might otherwise spark financial contagion.
But Mr. Wright warns that these tools may no longer be sufficient if credit continues to rise quickly.
“Threats to China’s financial stability are emerging now because the political bargain between Beijing and China’s households and investors is changing within an already large, risky, and complex financial system.”
China unleashed unprecedented monetary and fiscal stimulus in response to the 2008 global financial crisis and, in the years since, the country has seemed to be in permanent stimulus mode.
Rapid credit growth became the norm, interrupted only by brief and moderate tightening cycles. Much of this debt — though no one knows exactly how much — was used to fund projects that do not generate sufficient cash flow to cover interest payments, let alone the principal.
The biggest impact on foreign institutions from China’s debt pile would be if these problems lead to a severe growth slowdown. That would transmit pain to the broader swath of foreign companies that sell to China.
Some foreign equity investors would also feel a hit: their exposure to China is set to increase following the decision by index provider MSCI to increase the country’s weighting in its emerging markets index.