Could China Be Turning a Corner?
Doomsayers have plenty to work with in China. The country’s rapid buildup of debt -- reaching approximately 260 percent of GDP, from 160 percent less than a decade ago -- seems almost guaranteed to herald a financial crash or at least a major correction, quite likely followed by years of stagnation. If the world’s second-biggest economy ultimately defies the doubters, though, this may well be seen as the year things turned around.
Consider this: China is on track to see its best nominal GDP performance since 2011, even as credit growth remains moderate. First-half GDP numbers show that the economy is now requiring less credit to produce growth -- the least in six years, in fact. So far this year, it’s taken 2.9 renminbi worth of new loans to produce one renminbi of new GDP growth. That’s down from an average credit intensity of just over 4 renminbi in the first half of the year between 2012-2016, an almost 30 percent reduction.
Not enough attention is paid to China’s nominal GDP growth numbers. That’s in part because of the Chinese Communist Party’s own fixation on the real GDP growth target. It’s also because rising commodity prices are driving much of the recent improvement. The common argument is that higher steel, coal, oil and gas prices don’t signal a genuine improvement in economic momentum.
Yet China’s commodity producers and heavy industrial enterprises also happen to be the country’s most highly indebted businesses: They could use the help more than anyone. Chinese steelmakers are sitting on 38 billion renminbi in profits in the first five months of 2017, after making only 9 billion renminbi during the same period last year. Coal companies have raked in 123 billion renminbi through May. Improved nominal GDP performance has real implications for cash flows at these troubled companies.
The commodity boom is helping spur prices after years of deflation. A bit of inflation helps debtors to service their existing liabilities, which means they don’t have to take on as much new debt to pay off the old. And while most projections, including the government’s, are for upstream inflation to ease further throughout the rest of this year, price growth isn’t likely to fall back into negative territory. So, nominal growth should remain solid.
Most importantly, China finally seems to be grappling with its debt problems in ways that don't always make the headlines. Since the middle of 2016, China’s banking regulator has been pushing financial institutions to establish creditor committees to renegotiate their claims on companies. These committees are comprised of three or more lenders, so banks can’t negotiate against each other’s interests, and they address a fundamental problem: the frayed relationship that occurs between lenders and debtors in challenging economic times.
In practice, the negotiation process -- which generally takes place outside of and as a precaution against legal bankruptcy proceedings -- sees banks give borrowers a break in return for a clean and clear accounting of a company’s financial position. Generally, banks take some write-offs and extend loan maturities while lowering interest rates on some debt. Other liabilities can be transferred to a parent company, and sometimes a full-scale asset restructuring is initiated.
Because these committees are ad hoc institutions, there’s no overarching data tracking their proliferation. But, at the banking regulator’s March press conference, an official stated that 14.85 trillion renminbi in loans have been “dealt with” through 12,836 creditor committees nationwide over the past year. That covers 12 percent of corporate debt in China.
It’s unclear how banks are ultimately accounting for these loan renegotiations on their balance sheets, which will be an important question in assessing the health of the banking system going forward. But the effect on corporate balance sheets is unquestionably positive. By easing the financial burden on companies -- many of whom are also benefiting from improved cash flows because of higher commodity prices -- the committees should further reduce their need for new loans. That means the central bank should be able to slow bank asset growth without tanking economic performance as has happened during previous rounds of tightening.
None of this is to say that China is truly out of the woods. An improvement in the structure of existing credit needs to be matched with an effort to get new credit flows into more productive parts of the economy. So far it seems that a tighter focus on financial speculation has simply driven new lending back into property markets. So there’s plenty of work left to do.
But the central bank has always been clear that any genuine deleveraging would be a multi-year process. Improving the relationship between new credit and new GDP growth is an essential and welcome first step.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
To contact the editor responsible for this story:
Nisid Hajari at firstname.lastname@example.org