Is Debt Killing China?

In a new report, Global Source Partners analyst Michael Pettis gave his take on China and voiced his concerns over the role that Chinese debt is playing in the nation’s slumping economy. Pettis sees a close relationship between debt level and growth rate and points out that many economists seem to be missing the connection.

Bad Habits

According to Pettis, the current predicament in China has come about because of the economic system that has been in place in China for decades.

“The combination of high debt levels, a financial sector that plays a key role within the country’s economic model, and over three decades of high growth has, by consistently rewarding certain types of risky behavior, left the country with a balance sheet that systematically enhances volatility,” he explained.

The end result of this system has been the consistent downside growth surprises in China since 2012. Pettis believes that the country’s debt burden will continue to produce disappointing growth numbers.

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Ramifications

Pettis predicts that as debt levels continue to rise, global markets will grow increasingly uncertain about a resolution to China’s debt problems, and the issues could become compounded.

“A long period of high or rising financial distress can be as damaging for an economy over the long run, and even more so, as a financial crisis,” he warned.

Limited Options

Some analysts propose that China can scale back its credit growth by re-shaping its financial sector so that it preferentially provides capital to the most productive members of the economy. However, Pettis points out that “few, if any” countries have ever achieved such a level of financial sector transformation without an extreme, imminent economic motivation, such as a banking collapse.

Pettis sees the debt problem as a major obstacle for XI Jinping’s administration in coming years and believes that the issue is already constraining the country’s policy options.