While investors remain anxious about China’s transition to slower growth, there are good reasons to believe that the country could avoid a crash, according to Legal & General Investment Management (LGIM).
The sharp rise in Chinese debt in recent years has raised concerns about a hard landing, but LGIM believes there is a possibility that China could achieve a gradual slowdown in growth, averting a major macro shock.
“Broadly there are three reasons for our view. First, deleveraging pressures in the economy as a whole are not intense, there is also flexibility available in implementing macroeconomic policy measures and there is already evidence that some structural reforms are starting to take effect” said Brian Coulton, economist at LGIM.
The overall level of debt is not excessively high by international standards and is mainly funded domestically, according to Coulton.
He pointed to a surplus of savings in the household sector, which is more than sufficient to fund the borrowing requirements of corporates. The interest burden faced by the corporate sector is also rising but remains relatively low.
“While policy choices are more constrained than in the past the Chinese authorities still have the option of easing monetary policy,” said Coulton.
“In contrast to some emerging markets China is unlikely to see its monetary policy choices restricted by swings in global capital flows. This flexibility should help to smooth the path towards lower growth.”
Last November’s Third Plenum meeting set out a very strong agenda with the aim of reinvigorating the role of the private sector in the economy, increasing market pressure on state-owned enterprises and encouraging the rebalancing of the economy towards the consumer and service sector.
Seven months on, the reforms are already coming through, with evidence of progress in state enterprise reform.
“None of this is to deny the risks that have built up in the aftermath of the recent rise in debt. The rapid expansion in the shadow finance sector, the potential for non-performing assets to emerge in the banking system and the possibility of mistaken choices in a more constrained policy environment all pose a threat,” added Coulton.
“But a path for the economy that involves a gradual stabilisation in the credit ratio to GDP and a better allocation of credit without an abrupt macroeconomic shock, does not look out of reach.”