by Jan Goller

China’s current economic situation seems to be a bit strange at a first glance: While its economy is growing more slowly than the years before and the debts are rising, the Chinese government invests money into local infrastructure. Experts from the global rating agency S&P predict China to face this year a faustian choice between growth or debt reduction. Planned stimulus to boost output and business sentiment in China could undermine the country’s deleveraging push. This leaves policymakers with a tough choice between missing targets on growth or on reducing financial risks.



China’s Growth-Leverage Dilemma

S&P expects China’s growth to remain above 6% in 2019. “It still has the policy space to guide for a gradual slowdown. However, the risks are mostly on the downside”, says the agency’s Global Ratings chief economist for Asia-Pacific, Shaun Roache.

Key risks to growth are

  • a worsening of the trade relations between the United States and China
  • a failure of easier financial policy settings to transmit to China’s real economy amid poor business, consumer and investor confidence.

For example, policymakers are trying to steer liquidity to the private sector. Traditionally, it has had less access to bank loans than state-owned enterprises and local governments. But banks have been reticent to follow these guidelines.

The government wants banks to lend to small and midsized enterprises at ‘affordable’ rates. But this runs the danger of risk mispricing. In general, banks assess higher risks for private than for state-owned enterprises. This is reflected in higher lending rates, adds credit analyst Ryan Tsang.



Despite rising debts more investments

Over the past two years, many Chinese state-owned and local governments have made some headway in deleveraging, or reducing debt levels compared with the value of assets or GDP. However, in recent months the central government has begun encouraging more investments – for example into local government infrastructure.

Due to the complexity and uncertainty over debt reduction the credit analyst, Vera Chaplin, predicts the Chinese economy to grow at 6.3% in 2019. This means a lesser eleveraging than original anticipated.

Another stimulus option is to decrease restrictions on property, at the risk of undoing two years of tightening efforts to rein in price appreciation in the sector.

Although the government has said that restrictions will remain unchanged for now, it has room to maneuver. It will likely selectively and moderately loosen policy if the residential property downturn is too sharp, explains credit analyst Christopher Yip.