China has been on a credit growth spree since 2008, when Western households began to deleverage in the face of the global financial crisis hurting Chinese exports.
Societe Generale's Wei Yao writes that China's debt level has since surged to 210% of GDP, from 150% of GDP in 2008. And the problem is it's taking more and more credit growth to deliver less and less economic growth.
Chinese policymakers are well aware of the dangers of this rapid growth in debt, and the "alarmingly high level of corporate debt." And the shadow banking system is only making this problem worse.
"Deleveraging will be the biggest source of downside risk to China’s medium-term outlook," writes Yao. While some argue that the underlying assumption is that the state will guarantee its debt, it is important to remember that China's financial system is liberalizing and this means moving away from "100% state guarantees."
To tackle this massive debt problem, Chinese policymakers are employing a three pronged strategy. 1. They are trying to slow credit growth so the debt risk accumulates at a slower pace. 2. The less toxic part of bad debt needs to be rolled over with new financial instruments, taking the pressure off banks. 3. Non-performing loans are being disposed of.
Here's a visualization of that strategy and how it will impact growth:
China has been one of the few countries that has successfully managed to deleverage in the past without seeing a sharp correction. "This means that there is a glimmer of hope that China may be able to do it again," says Yao.
Here's the main difference between now and then from SocGen:
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