China's Minsky Moment?
With the Hang Seng China Enterprises Index up 20% year on year, the recent Chinese stock sell-off was regarded as an overdue market correction. As investors look to seal in strong gains in technology stocks in particular, the market is now 6% lower than the peak, as evident in Figure 1.
In the wider economy, despite resilient growth figures for Q3 2017 exceeding the annual 6.5% growth target, loose credit and debt financed investments continue to pose risks in China. With the IMF reporting that debt has now ballooned to 234% of the country’s total output, concerns over China’s credit expansion prompted S&P Global Ratings to cut China’s credit rating in September. Indeed, China’s high debt-to-GDP ratio would suggest vulnerability within its financial system, especially given the rate at which debt is accumulating; this has resulted in fear of a ‘Minsky Moment’ in the world’s second largest economy.
(N/B: as defined by the FT, the Minsky Moment ‘is a sudden collapse of asset prices after a long period of growth, sparked by debt or currency pressure’)
Indeed, unlike the self-sustaining global growth uptick of 3.6% for FY 2017, China’s 6.8% growth rate for Q3 2017 is dictated by inputs, rather than outputs into the economic system, as government borrowing ensures desirable GDP levels are reached. Whilst this borrowing brings growth forward, the opportunity cost involved in servicing the debt raises concerns, especially if current investments are unproductive.
On the other hand, China does have relatively low interest rates and a current 48% domestic savings rate of more than double that the USA’s, with $6 trillion of savings added each year. Under such context, the vulnerability caused by China’s debt crisis is open to debate.
Regardless, Xi Jinping and the central government is shifting emphasis away from GDP growth in order to deflate financial risks, as promised in recent party meetings.
Most recently, the PBoC has focused on tackling the shadow banking sector, as new draft rules try to tackle risky Chinese asset management products and ‘prohibit asset managers from promising investors a guaranteed rate of return’, as reported in the FT. With what promises to be a more coordinated approach to regulation and tighter credit especially for vulnerable borrowers, this has already impacted the bond market, long before its June 2019 introduction. Notable cuts have also been made to central bank cash injections, aligning with the government’s change in focus regarding the financial markets.
Regulatory tightening has hit at a time global monetary tightening appears to be around the corner. This potential, coupled with greater inflationary pressure from higher than expected GDP growth, has caused sovereign bond yields to shoot up (see figure 2 below). With rising rates and tighter credit, defaults may well increase.
As evidenced by the reactions to the regulation updates, the market is certainly taking the government’s attempts to tackle China’s debt fuelled growth seriously. However, with growth targets to be set in the coming months, Reuters has reported China’s 2018 growth targets are likely to be maintained at “around 6.5%”. Despite suggestions from sources such as the IMF that China should instead focus on shifting towards more productive and sustainable investments, it would appear resilient growth is staying with us.