Quiver Quantitative - China, the world's second-largest economy, is now confronting substantial fiscal and financial disparities, which include a declining property market, local governments in debt, and a vulnerable banking system. Historically, these issues would suggest an impending financial crisis. However, conventional belief held that China's primarily domestic debt and the government's control over the financial system would protect it from such a crisis. Yet, reports from the International Monetary Fund (IMF) indicate potential vulnerabilities: China's economic growth rate is slowing, local governments are sinking under debt, and banks are not sufficiently capitalized. If China's fiscal imbalances lead to a financial downturn, even though the Chinese banking system is somewhat insulated from global markets, the magnitude of China's economy means global repercussions are inevitable.
These concerns arise from the following data: The IMF projects China's growth to average only 4% over the next four years, a decrease from previous expectations. Furthermore, the IMF forecasts China's government deficits to reach 7.8% of its GDP by 2028, a sizable increase primarily attributed to local governments' debts, which now account for about 45% of China's GDP. These local governments have relied heavily on land sales for revenue, but as this source dwindles, nearly a third of local governmental financing strategies may not be viable without state support. This poses a significant risk to Chinese banks, which hold approximately 80% of that debt.
While China has historically managed its debts by assuming Beijing's intervention and bailout, such beliefs are based on implicit guarantees rather than explicit ones, introducing a potential risk. A shift in perceptions about these guarantees can drastically alter market confidence. As Logan Wright from Rhodium Group observes, a crisis in China may not necessarily stem from an external jolt but rather from the swift reevaluation of assets when investors realize the government might not support their investments as previously believed. This could result in a cascading loss of trust in assets, ranging from real estate to local governments.
Chinese authorities, cognizant of the looming threats, have initiated measures to restructure local debts and guide struggling developers. However, experts like Martin Chorzempa from the Peterson Institute for International Economics believe that China's current debts are too vast and its economic growth too sluggish for the country to merely absorb bad loans as it did two decades ago. The potential economic and financial stasis in China could adversely affect global trade, suppressing import demand while bolstering exports, which would exert pressure on global producers.
This article was originally published on Quiver Quantitative