China’s Tricky Tradeoff


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What's going on?

Late on Wednesday, Chinese leaders finalized a plan for the future of the world’s second-largest economy under President Xi Jinping. But their economic roadmap had little to say about excessively high debt levels that threaten to undo the country’s prosperity…

What does this mean?

Despite some signals earlier this year that China was committing to tackling some of its structural economic weaknesses, authorities this week appeared reluctant to go much further. A large number of Chinese corporations remain dependent on state subsidies, and the country has a high debt burden, particularly in the private sector.

One reason for the feet-dragging could be that China is finding stricter rules on credit and debt will lead to a decline in economic growth: the country’s leadership is picking sides in a risky tradeoff between between financial stability and economic activity.

Why should I care?

For markets: There are already wobbles in the Chinese house of cards…

While there are some signs to the contrary, it’s clear that overall indebtedness in China is still high. Observers of all stripes, ranging from the IMF to credit ratings agencies like Moody’s, have been raising red flags this year about the potential risk of this amplifying the effects of any economic downturn. And if the Chinese economy were to take a turn for the worse, the impact would very likely be felt across the world.

The bigger picture: Europe may serve as a warning for China.

Earlier this year, China overtook the eurozone to become the world’s largest banking system in terms of assets (banks’ assets are usually loans that they have made). Before the 2008 financial crisis, European banks lent like crazy to firms, helping fuel unprecedented economic growth in countries like Spain, Portugal and Greece. But the subsequent economic downturn was amplified by the high levels of debt held by banks, and many of those regions in Europe are still scarred by the legacy of overborrowing.

Originally posted as part of the Finimize daily email.

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