The chances of a hard landing are remote.
Legendary investor George Soros recently delivered new warnings on China, saying that the world’s second largest economy is facing a financial crisis similar to the U.S. in 2008. His remarks double down on his earlier comment that a hard landing for China is inevitable. Soros definitely has a point, but China’s economy is not as doomed as he suggests.
Let me acknowledge that my views are not entirely unbiased because as someone who lives in China I am aboard what some, like Soros, say is a sinking ship; if the ship goes down I will definitely be hurt. The statistics Soros recently gave are undeniable facts. China’s new credit increased by more than expected last month. The overall debt level has reached historic highs. GDP growth is slowing down. And yes, there is a serious overcapacity issue for certain industries. However, I do not agree with Soros’ gloomy prediction of a hard landing for China’s economy in the near future or the debt being comparable to what happened in the U.S. in 2008.
First, China’s credit-to-GDP ratio is about 240%, only slightly higher than the 233% level in the U.S. That’s still far lower than Japan’s 400% and the U.K.’s 252% levels. If we break down China’s 240% credit-to-GDP ratio, government, households, and non-financial corporations respectively contribute 56%, 40%, and 144%. China’s non-financial corporations’ high leverage ratio indicates that the country is relying on indirect rather than direct financing due to its under-developed stock and bond markets, which have only been around for the last 30 years.
Meanwhile, the leverage level for government and households is much lower than that in the U.S. As we have learned, the 2008 financial crisis was largely triggered by the over-leveraging of the average American household. Today, China remains the country with the world’s highest saving rate at 50%, compared to 16% in the U.S. The country has accumulated more than 120 trillion renminbi of financial assets. Of that amount, 55 trillion renminbi is in bank deposits, which is relatively easy to convert into cash. So the average Chinese household’s balance sheet is much healthier than that in the U.S. It provides enough reserves and confidence to weather an economic storm.
Soros, and many others who are bearish on China, often point to an increase in investors’ capital leaving China as signs of the country’s impending doom. What’s important to note, however, is that the outflow of capital accelerated on investors’ expectations that the value of China’s currency would weaken. Investors’ outlook changed when the U.S. Federal Reserve did not announce interest rate hikes after meetings in January and March. China has recently seen net capital inflow. The foreign reserve is still at very high levels, $3.3 trillion, which does not include the sovereign fund of $0.85 trillion. At the same time, there is still a surplus in the current account. And despite the non-performing loan ratio recently increasing to 2%, it still looks trivial compared to the 25% China had in 1997. The share of non-performing loans relative to GDP ranges between 7% to 14%, compared to 35% to 40% in 1997. The current capital adequacy ratio is 13.5%. And the required reserve rate (RRR) is 17.5%. Therefore, China’s banking sector is much healthier than it was in 1997.
Additionally, there is still room for China to grow. The country’s GDP per capita is only $8,000, while in the U.S. it is $54,000. The urbanization ratio in China is 56%, while in the U.S. it’s close to 80%. To me, that suggests China’s economy has not reached its full potential. The development theory tells us that the driving forces behind economic growth are human capital, financial capital, and efficiency and innovation. China has shifted its priority to quality of growth away from the previous pursuit of speed. Even the GDP growth rate has reached its new normal of 6.5%, a figure that is still impossible for most countries to achieve.
Yet despite my slightly optimistic assessment of China’s economy, I am not turning a blind eye to the toughness of the government’s ongoing structural reforms. They require determination, braveness, and concrete actions, such as laying off more than five million workers from industries in which there is obvious overcapacity (like coal, steel and shipping), reforming state-owned enterprises, and reversing the trend of diminishing marginal return from investments. These reforms are stepping on the toes of interest groups, which can cause short-term societal confusion. But doomsday predictions, which do not put the numbers into context, are not constructive and do not make the problems go away. Using scare tactics to weaken the world’s second largest economic engine does not benefit anyone except for the hedge fund with a short position.
In the end, I believe the chances of a hard landing for China are remote. And even if there is a hard landing, I think China has enough of a cushion to recover.
Oliver Rui is a professor of finance and accounting at China Europe International Business School (CEIBS).