Why China is not on the edge of a financial crisis

After the happening of the 2007-2008 global financial crisis, a number of economists and even famous businesspersons had predicted that the next global crisis would stem from China because of the fear about the slower economic growth, large fiscal deficits and real estate bubble. For example, as early as 2013, Hong Kong property tycoon Li Ka-shing had been selling his assets in mainland China and Hong Kong and moved his family wealth to UK. Many believed that Li’s withdrawal from China showed the market fear of a possible hard landing of the Chinese economy. However, similar to the fact that economists always failed to predict a financial crisis, China is actually NOT on the edge of a financial crisis for the below reasons:-

The debt-to-GDP ratio in China is still safe

Debt-to-GDP Ratio is a ratio of a country’s national debt to its GDP. The debt-to-GDP ratio is one way to estimate whether or not a country will be able to repay its debts (investopedia.com 2016). A debt-to-GDP ratio of 60% is quite often noted as a prudential limit for developed countries, crossing this limit may affect the fiscal sustainability; as for developing countries, 40% is the recommended debt-to-GDP ratio following which helps maintain a long-term fiscal health (voxeu.org 2016). In case of China, as of beginning of 2016 its government debt to GDP ratio is 41.14%. Though it is a record high for China, it is still considered as reasonable. In comparison, Japan’s debt-to-GDP level is 229.20% and United States’ ratio is 104.17 (tradingeconomics.com 2016), both exceed the recommended safe level. Obviously, the debt-to-GDP ratio in China is still safe.

Effective government intervention

The Chinese central government has been well aware of the structural vulnerabilities of the Chinese economy. The Chinese state media Xinhua has repeatedly argued that the government is working hard to avoid a hard landing of the national economy in the years to come (chinadaily.com.cn 2016). Most Chinese banks are stated owned or heavily influenced by the central government, therefore it is for sure that China will not hesitate to bail out the possible failing banks. As a matter of fact, last year the Chinese government even go to the rescue the failing stock market with trillions of yuan though the result was not satisfactory (cnn.com 2015); but still it showed that the government’s market rescue efforts will be in place when it is needed.

China is a substantial net creditor

China had moved quickly from a net debtor in 1999 (net foreign liabilities accounted for 9 per cent of GDP) to being a substantial net creditor (30 percent of GDP in 2008). The substantial net creditor position ensures that China’s central bank can provide sufficient liquidity support and restore market confidence within a short period of time and thus China is unlikely to undergo a foreign-exchange or national insolvency crisis.

Tight exchange controls on capital market

China prohibits its private sector from freely trading foreign assets and tightly manages currency exchange rates (the government attached its value to “the basket of currencies” and allows limited fluctuation of the value of the yuan). In fact, such capital movement control and tight exchange rate management proved to be playing a key role in helping China to withstand the Asian financial crisis in 1997.

Why China is not on the edge of a financial crisis

List of reference

cnn.com 2015 China is trying to save its market with failed policies [online] accessed on 7th Apr 2016, link: http://money.cnn.com/2015/07/30/investing/china-stock-market-crash/

chinadaily.com.cn 2016 Chinese economy can avoid hard landing in years tocome: FitchRatings [online] accessed on 7th Apr 2016, link: http://www.chinadaily.com.cn/business/2016-04/07/content_24342038.htm

investopedia.com 2016 Debt-To-GDP Ratio Definition | Investopedia [online] accessed on 7th Apr 2016, link: www.investopedia.com/terms/d/debtgdpratio.asp

tradingeconomics.com 2016 Country List Government Debt to GDP [online] accessed on 7th Apr 2016, link: http://www.tradingeconomics.com/country-list/government-debt-to-gdp

voxeu.org 2016 Is there an optimal debt-to-GDP ratio? [online] accessed on 7th Apr 2016, link: http://www.voxeu.org/debates/commentaries/there-optimal-debt-gdp-ratio

Leave a Reply

Be the First to Comment!

Notify of