Tuesday, October 18, 2016

Australians are ignoring a crisis that's bigger than Brexit: Chinese debt

When our buttoned-down economic guardians start using words like "disruptive adjustment" it's a sign something's amiss.

Over the past few weeks both the Reserve Bank and the International Monetary Fund have used that same ominous phrase with reference to Australia's biggest trading partner, China

In essence, the problem is a corporate debt binge. Credit growth in China has accelerated and is growing at twice the pace of its economic growth rate. Debt levels have ballooned to 250 per cent of gross domestic product and alarm bells are ringing.

So how worried should we be here in Australia?

No one knows for sure, but probably a fair bit.

Economists often resort to the term "uncharted waters" to describe unusual conditions but in this case the cliche is apt. It is notoriously hard to predict how and when debt bubbles will unwind in the most transparent of democratic systems. In a huge one-party-state like China it's even more mysterious.

Few institutions have invested as much over recent years in understanding the Chinese economy as the Reserve Bank of Australia.

In its regular review of financial stability, released on Friday, it described China as "a key locus of risk" given its increasing size in the global economy and the run-up in borrowing.

"The potential for a disruptive adjustment in China remains pronounced, given the ongoing increase in debt," it said.

The sheer pace of lending growth makes it likely many loans are going to marginal borrowers or unprofitable projects. China's growth is slowing and that will make it harder for highly leveraged firms to service their debts, especially if loans have funded unviable projects. To make matters worse much of the rapid growth has been from China's less regulated "shadow banking" sector.

China's financial system "has become increasingly large, opaque and interconnected," the Reserve warned.

The IMF's regular assessment of the Chinese economy, released in August, called on authorities to "tackle" the debt problem urgently.

Luckily, Chinese authorities have the capacity to deliver more economic stimulus if needed.

But the difficult remedies required to return China to a more sustainable rate of credit growth are likely to "displace" workers and take a toll on growth. Any artificial measures used to try and postpone the inevitable adjustment are likely to make it even more disruptive. And any policy missteps along the way could deepen the slowdown.

The IMF says there's "a tangible risk of permanently lower medium-term growth".

Of course, a sharp slowdown in Chinese growth would hit our economy harder than most and put many jobs at risk. Australia has the highest proportion of exports going to China of any advanced economy.

Last financial year it accounted for more than 30 per cent of Australia's merchandise exports, up from about 10 per cent a decade earlier. It's also our largest market for services exports having jumped from around 3 per cent of the total to 15 per cent in just 15 years. China is Australia's second largest source of tourists and they spend far more than the average overseas visitor. China is also a key market for Australia's international education industry.

What's surprising is that the potential fall-out from China's debt binge doesn't get much more attention here. The Reserve Bank's warnings about China last week didn't dominate the headlines. They were eclipsed by another financial risk highlighted in the report – how a glut of inner-city apartments could leave highly leveraged investors and property developers exposed should prices slide.

In the first of three "headland" speeches in late August the Treasurer, Scott Morrison, also canvassed the economic threat posed by rising corporate debt and slowing economic growth in China. "Interesting times may lay ahead, and we must prepare," he said.

It is rare for an Australian treasurer to talk about the risks that come with Australia's extensive economic ties with China, not just the opportunities. But the warning was again overshadowed, that time by Morrison's remarks about "the taxed and the taxed nots" – how more Australians are likely to go through life never paying more tax than they receive in government payments than in the past.

The amount of quality news and financial analysis about Asia in the Australian media has improved over the past decade or so. But analysis of the Chinese economy is still routinely eclipsed by financial news from Europe and North America. We still pay disproportionate attention to financial events in America and Britain even though those places have become less important to us economically. The blanket coverage of Brexit is a case in point – there's no doubt the aftermath of China's credit boom poses a much bigger economic threat to Australia than Britain's withdrawal from the European Union, but the balance of media coverage here doesn't reflect that.

Despite our growing economic integration with the Asia, deep curiosity about the region remains strangely limited. 

It's high time that changed.

Matt Wade is a senior writer for the Sydney Morning Herald llustration: Simon Letch 

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