Could China’s credit slowdown lead to a crash?

published 18 April 2014

Markets took some comfort this week from data showing that China's economic growth slowed by less than feared in the first quarter of this year. GDP growth came in at 7.4% over the first three months of 2014, from 7.7% in the fourth quarter of last year. "However, that was it for the good news," says Socit Gnrale's China economist Wei Yao.

Companies are complaining of a double whammy of rising costs. Wages are surging as the supply of cheap labour from the countryside dries up. Meanwhile, a credit crunch engineered by a government keen to cool lending down has pushed up the cost of borrowing.

As a result, says Keith Bradsher in the International New York Times, finding the funds to finance "everything from raw material to new equipment" has turned into "a crippling challenge for businesses and individuals without the political connections to borrow at regulated rates from the state-controlled banking system".

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This drop in lending has been led by the shadow banking system (a term that simply describes any lender that isn't a bank), according to Wei Yao. Lending by trusts (companies that take investors' money then lend it out) has cooled the most, followed by corporate bond issuance by non-financial firms.

"China's credit slowdown seems to be increasingly market-drivennow, due to rising risk aversion among lenders." "Pessimists worry about a catastrophic crash" driven by baddebts and collapsing credit availability, saysSatyajit Das in The Independent.

The optimists insist that "debt levels are manageable because of high growthrates" and that "reform programmeswill ensure a smooth transition", with China "rebalancing its economy from investment to consumption". Both sides are wrong. Defaults will be managed.

"As in a shell game, bad debts will be shuffled from entity to entity." Unfortunately, maintaining this illusion of stability will entail ongoing financial repression', with interest rates kept below the rate of inflation. That will keep households' buying power weak, which in turn will make it harder to encourage more consumption.

In the end, "China's Potemkin economy of zombie businesses and banks will create progressively less-real economic activity".

Andrew is the editor of MoneyWeek magazine. He grew up in Vienna and studied at the University of St Andrews, where he gained a first-class MA in geography & international relations.

After graduating he began to contribute to the foreign page of The Week and soon afterwards joined MoneyWeek at its inception in October 2000. He helped Merryn Somerset Webb establish it as Britain’s best-selling financial magazine, contributing to every section of the publication and specialising in macroeconomics and stockmarkets, before going part-time.

His freelance projects have included a 2009 relaunch of The Pharma Letter, where he covered corporate news and political developments in the German pharmaceuticals market for two years, and a multiyear stint as deputy editor of the Barclays account at Redwood, a marketing agency.

Andrew has been editing MoneyWeek since 2018, and continues to specialise in investment and news in German-speaking countries owing to his fluent command of the language.