China – Sailing between Scylla and Charybdis

Two macro numbers, published by the Chinese authorities this week, show that China has decided which way to go for the economy, at least for now. Credit growth and GDP growth came in higher than expected; emphasizing that growth remains China’s number one priority.

This week I mentioned in a tweet that China is in a precarious situation, comparable to sailing between Scylla and Charybdis, a voyage that will result in at least some damage. Scylla, a six-headed sea monster, and Charybdis, a giant whirlpool, are two sea creatures from the Greek Mythology located in the Strait of Messina between Sicily and the Italian mainland. They were situated so close to each other that, in order to cross the strait, passing sailors were forced to choose which monster to face.

China must feel it is stuck in its own Scylla and Charybdis like dilemma. China has to make a choice between allowing the unsustainable level of credit growth to continue in order to keep GDP growth high, or dealing with the credit bubble that is already a fact at the cost of a significant lower pace of GDP growth.

Based on recent data we have to assume that, at least for now, China is opting for the first. The graph below shows that aggregate financing, or total social financing as this figure is often referred to (since it involves all fundraising including non-financial corporates and individuals), is on the rise.

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The ‘proof’ that China is allowing credit growth to prevent GDP growth from falling was delivered shortly after the aggregate financing numbers. GDP growth for the second quarter came in at 7.5%, 0.1% above the 7.4% that was expected, and exactly in line with the Chinese target.

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Now, one could argue that credit growth, the change in the amount of outstanding credit from the previous year is coming down. Recent numbers show that credit growth is currently around 17%, which is near the lowest in the last decade. Still, that number is considerably higher than (nominal) GDP growth, which means the total ‘stock’ of debt in the economy is rising. As the next chart, taken from the BIS website, shows, the total amount of outstanding debt to GDP ratio has skyrocketed.

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With a private sector debt-to-GDP level of over 200%, leverage in the Chinese economy is already pretty stretched. Fueling growth by adding even more debt is bound to cause problems somewhere along the line. Already, news items of companies having difficulties to pay off or refinance their loans are popping up. Today, Reuters wrote that Builder Huatong Road & Bridge Group is uncertain whether it would be able to pay interest or principal on a one-year bond. A default would be the first default on the Chinese primary bond market.

However, as of yet, there are no signs that China is about to change course in its way through Scylla and Charybdis, and allow the GDP growth number to fall.

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