The Financial Times Stock Exchange All-World Index rose by nearly 22 per cent in 2017 — its best performance since the post-crisis rebound in 2009. In the United States the prediction of 2.3 per cent growth this year last October now looks conservative.
China’s growth last year appears to have nudged the magic 7 per cent. While that is well below the growth rate China notched up last decade, the scale of it means that China’s contribution to global output in absolute terms is bigger today than it was when the Chinese economy was clipping along at a heady 10 per cent per annum plus.
Many reckoned that China was headed for a sharp slowdown coming at the end of its political cycle last year. So far that risk has been kept at bay.
Ideas of secular stagnation in industrial economies have begun to fade. While productivity growth still appears on the wane, the global mood has turned bullish across the developed and emerging worlds.
As monetary policy and global capital markets begin to tighten, the caution in the global economy is now sharply focussed on debt levels. Nominal interest rates are set to climb from their historic lows. That will make high debt levels more problematic, which will potentially check growth by triggering disorderly deleveraging. Inflation slack may ease the capital market transition globally, but in China, effecting financial market reform while managing substantial corporate debt deleveraging presents another order of systemic risk.
China now accounts for a smidgen under 15 per cent of global output but its contribution to global growth is twice that share. Yet, as the IMF has lifted its forecasts for Chinese growth, global sentiment on Chinese debt risk has grown more pessimistic because of fears about Chinese corporate debt and adverse economic shocks.
Maintaining financial stability is a top policy in China today, as People’s Bank of China (PBoC) Governor Zhou Xiaochuan has recently made clear.
What are the prospects of getting it right?
In this week’s lead essay, Yu Yongding points out that China’s corporate debt-to-GDP ratio is actually falling. ‘The leverage ratio of China’s non-financial corporations fell by 0.5 percentage points in the third quarter of 2016 and has continued falling since. In the first quarter of 2017, the debt-to-GDP ratio of China’s ‘above scale’ industrial corporations fell by 0.7 percentage points year-on-year. After the dramatic correction in 2015, China’s equity market is basically stable. The price/earnings ratio and the price/book value ratio fell from 54 to 19 and 8.5 to 2.3 respectively. Further large falls in share prices in China are unlikely’.
The Chinese debt market has calmed. In 2016, there were 19 defaults involving a total of 28 billion RMB (US$4.32 billion). In 2017, nine defaults totalling 4.8 billion RMB (US$740 million) have so far been recorded. Compared with the scale of China’s corporate debt market, these figures are not important enough to be a worry.
China’s banks are fraught with many problems, but their performance, Yu suggests, remains among the best in the world. Their ‘average return on equity, non-performing loan provision coverage ratio, loan coverage ratio, capital adequacy and non-performing loan ratio are 13.4 per cent, 176.4 per cent, 3.1 per cent, 13.3 per cent and below 2 per cent respectively. Even if the real situation of Chinese banks is much worse than those indicators suggest, it is difficult to believe that China’s banks are heading for financial crisis’.
For those who believe that China is facing an imminent Minsky moment, Yu concludes that the policy priority should be financial deleveraging even if this slows economic growth. While a surge in optimism for China’s growth in 2018 is hardly justified, the claim that it faces imminent financial crisis does not ring true either.
The PBoC has announced that its strategies to preserve financial stability include continued opening-up and the deepening reform of financial markets, liberalising domestic financial markets, easing foreign exchange market controls as well as further liberalisation of the renminbi. The Bank is highlighting its enlarged role not only in monetary policy control but also over macro-prudential policy (the so-called ‘two-pillar macroeconomic regulatory framework’). Monetary policy will target aggregate price stability and promote economic growth, while macro-prudential policy will be directed at the financial system integrity and stability.
In Washington last week, while prominent US China economy watcher Nick Lardy worried about the trend towards state-sector debt-driven growth in the Chinese economy and its crowding out productivity-enhancing private investment, Yiping Huang, chair of the just-released an influential Jinshang Report on Chinese financial reform, endorsed coordination of ‘reform through opening’ and ‘facilitating opening through reform’. He tipped the already-announced lifting of equity limits for foreign institutions, a rollback of temporary capital flow restrictions, an acceleration of renminbi internationalisation, increased exchange rate flexibility and further opening of domestic financial markets through the year.
China has fiscal room to move. A poor growth performance, as Yu says, would undermine financial stability, and financial instability would jeopardise growth. Success with financial and structural reforms — even more than government-promoted innovation — will be the key to reinvigorating the entrepreneurial energies that are crucial to sustaining the long-term Chinese growth in which the world now has such a substantial stake.
The EAF Editorial Board is comprised of Peter Drysdale, Shiro Armstrong, Ben Ascione, Amy King, Liam Gammon, Jillian Mowbray-Tsutsumi and Ben Hillman, and is located in the Crawford School of Public Policy, College of Asia and the Pacific, The Australian National University.
This article is part of an EAF special feature series on 2017 in review and the year ahead.