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Slaying The Chinese Dragon: Can China Go Bankrupt?

A government that relies on economic development as the main source of legitimacy cannot let a slowdown continue for long.

China has long enjoyed the benefits of sustained economic growth while also treating financial management with noticeable dereliction. As the Chinese economy begins to slow down and the political pressure for economic sustainability becomes more challenging, the greatest political pressure China faces in the near future is itself.

On 17th May 2017, Moody’s, one of the three agencies rating the solvency and risks associated with government budgets downgraded the rating of China’s debt from an AA- to an A+. A+ is the fifth highest rating a state may have. It suggests an overall capacity to meet its debt but some susceptibility to the changing nature of the global economy. The reasons behind the downgrade are largely associated with the debt-driven stimulus packages China is implementing at home and abroad.

The Chinese government has attempted to initiate this stimulus as a kick-start to increased economic growth. However in March 2019, Chinese Premier, Li Keqiang suggested that economic growth forecast for the fiscal year was to be around 6 to 6.5%.This is just the latest indicator of China’s economic slowdown. Accompanied with this slowdown is the ever increasing Chinese debt situation. It includes business, government and households and stands at 250% of GDP or $32.1 Trillion (USD).

The debt crisis began in the wake of the 2008 financial crisis. The economic outlook was projected to fall below government expectations, although posting 6.1% growth in 2008. The repercussions of western recessions affected Chinese exports, which were the driving force of the economy. To avoid a similar fate, the Chinese government transformed the economy by placing a heavier reliance on domestic demand. This domestic demand was accompanied by two stimulus packages. The first was mass scale investment in infrastructure projects, such as the Beijing Olympics, multiple skyscrapers and transportation networks. The second was a reduction in taxes, in order to provide cheap loans to the population and facilitate domestic spending.

Many Chinese state-backed companies have engaged in spending through enterprises that would not be profitable. Image: Pixabay.

Traditional economics suggest this is often a recipe for disaster. As government expenditure increases and government revenue decreases, the fear of an unsustainable debt becomes greater. The main cause of the unsustainability of the Chinese economy is related to the relationship between the Central Bank of China and the companies that hold the increasing debt. Interest rates remained low, which meant that money was cheapIn other terms, the Central Bank was essentially giving money away for free. This echoes the financial mismanagement that occurred in the west prior to the Global Financial Crisis.

The damaging nature of these loans is not the loans themselves but the lack of checks and balances relation to the spending they permitted. Many Chinese state-backed companies engaged in spending through enterprises that would not be profitable. One example is the establishment of the Chinese Super League. In order to pay these loans back, the companies requested new loans with a slightly higher interest. This created a never-ending cycle, and fails to sustainably reduce the debt through the normal operations of the market, which would be to focus on profitable industries. The underlying factor of the negligence of not adopting a checks and balances system was the adherence of state-owned banks loaning money to state-owned companies, in what can be termed credible corruption towards a false basis of economic growth.

The flow of money into the economy continues but the Chinese government’s involvement is hardly surprising. Just like in 2008, the government has recently stepped in to stimulate the economy during a perceived slowdown. A government that relies on its economic development as its main source of legitimacy cannot let a slowdown continue. But so long as the Chinese government is willing to give out loans at an unprecedented rate, economic growth will continue. The main question that is now posted to China is how to balance between greater levels of debt and greater levels of economic growth.

Conor Mclaughlin

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