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Since the turn of the millennium, the growth of the Chinese economy has been the biggest story for the global economy. However, in recent years, that growth has been too dependent on credit-fuelled stimulus. Non-financial sector debt has risen to roughly 250% of GDP. This rise in debt presents serious risks. According to the two best indicators to help gauge banking crises risks by the Bank of International Settlements (BIS), China is above the threshold signaling financial vulnerability.
In the first quarter of 2015, China's economy slowed to its weakest pace since the financial crisis. In response, Chinese authorities unleashed a sizeable array of stimulus measures while backtracking on certain reforms. Real GDP and a host of monthly indicators ticked up in the second quarter. However, there is a very real risk that growth flags again at the end of this year unless additional measures are undertaken. High financial vulnerability risks limit the available policy options to support economic growth. More interest rate cuts are likely, but rather than raise economic growth, they will simply offset elevated debt-servicing costs for businesses.
On a longer-term basis, economic growth is likely to continue to slow alongside structural forces and the debt overhang. Moreover, the need to deleverage or at least contain credit growth implies a continued economic slowdown, or China risks exacerbating the vulnerabilities within its economy. For the rest of the world, the implications are that China will continue to periodically drain demand from an already demand-short global economy. Expect to see continued bouts of market volatility as authorities try to navigate the trade-off between near-term growth and long-term reform. Slower Chinese growth partly explains why the price of non-food commodities remains subdued, and the feedback loop to other EMs suggests lower growth profiles than in the past, says TD Economics.
