Pudong Skyline. Photo: Pjt56. Source: Wikipedia
China is the second largest single economy in the world and over half the size of the US economy. It’s home to some of the largest – and fastest growing – tech companies: Tencent, Alibaba, Baidu, and others. And of course, over 1.4 billion people live there, the most populous nation on the planet. They import and export over $3.7 trillion of products every year. China’s growth over the past 30 years has been truly astounding, a miracle of modern development. But because it is both physically and culturally distant, we underestimate its importance.
The development story in China continues to unfold. Every year, millions of people from rural areas travel to more developed regions to find better opportunities. They leave lives of subsistence farming for employment in factories and tech firms, and become much more productive in the process. And the developed areas aren’t just on the coast. Hainan Airlines now has nonstop flights from New York to Chengdu, in Sichuan Province. For perspective, Chengdu is 1,200 miles from China’s coastline – about the distance from New York to Omaha, Nebraska.
Recently, the IMF issued an assessment of China’s financial sector – the sector that is funding China’s continuing growth. Total debt – government, corporate, and household – has grown in recent years to over 200% of the Chinese economy. There has been a lending boom to companies and local governments, and many of the borrowers have overextended themselves. Many risky borrowers, having been denied credit by banks, have moved to less regulated products, like peer-to-peer lending or shadow banks. At the same time, many savers are looking for higher-yielding assets. This has led to the growth of pyramid schemes and other kinds of financial fraud. And local governments are reluctant to let important companies fail. The lack of a social safety net means unemployment can lead to social unrest.
China Total Debt to GDP. Source: Bloomberg
Keeping pace with financial growth and innovation in one of the world’s largest and fastest growing economies is a challenging task. The authorities have begun to put a crisis management framework in place, but China’s opaque institutional structure is a problem. It’s hard to get accurate data in such a system, much less make informed regulatory decisions.
A stress test on China’s banks found that most didn’t have enough capital to withstand a significant systemic shock. China’s biggest banks are fine, but most of the regional and commercial banks are vulnerable. If they want to keep growing, the authorities need to place less emphasis on growth, and focus more on safety. That’s the only way to steer clear of another financial mess – one that would likely expand beyond China’s borders.
Because if they ring a bell in Shanghai, we’ll hear it in New York.
Douglas R. Tengdin, CFA