In recent years, China has exhibited rapid economic growth due to massive debt and injection of government subsidies. Leveraging is essential for funding modernization efforts, but when done excessively, it signals an unbalanced economy. Statistics given by Fitch (2013) show a rise in overall credit in China from US$9 trillion to US$23 trillion since 2008. If history is anything to go by, China is headed towards a banking crisis and severe credit crunch since credit is the lifeline for its state-owned companies (Chen 2006, p. 11).This essay reiterates the chances of China experiencing an economic crash if steps are not taken to curtail the spiraling liquidity.
The financial sector in China is susceptible to credit misallocation and high bad debts attributed to the growth of non-loan financial products (Borst2013, p. 17). The Lehman collapse in 2008 caused a sudden shrinkage of world trade and greatly affected export trading in China. This led to closure of factories and massive layoffs. The government injected funds totaling to 400£bn of direct government spending and directed state-owned banks to extend credit facilities to consumers (Preston 2014). This caused a surge in credit creation and large sums of money were poured into non-viable investments. Consequently, shadow banking activities conducted by non-bank lending institutions increased, accounting for an astonishing 60% of new credit issuance (Chancellor & Monnelly 2013).
Shadow financing poses dangers such as duration mismatch (short-term funds invested in long-term assets) and blind trusts where savers hand over their money without knowing which investments their funds will finance. In effect, the rate of default on loans has gone up as seen in 2011 when more than 80 business executives committed suicide or filed for bankruptcy to avoid repaying loans that carried interest up to 70% compared to the official lending rate of 6% (Collins 2013). Some experts advocate remedies such as forcing banks to reveal where they invest their money and enforcing bans on loans for multiple houses (Changxin 2013). However, these may not work if citizens are unsatisfied with a slowdown in economic growth from 7% to a projected 4%, since they crave for jobs and higher living standards.
Another signal for an economic crash is the real estate bubble in the country where increases in prices have exceeded the rise in income by 30% in Shanghai and 80% in Beijing (Balme 2011). The availability of credit has increased demand for houses causing excessively high prices which have deterred most citizens from raising the required 30-40% down payment. Guilford (2013) states that banks have devised illegal ways to help consumers make mortgage deposits such as introducing informal version of reverse mortgages that allow parents of buyers to take loans using their homes as collateral to generate the cash. They end up lending to the same category of non-creditworthy consumers. Moreover, the variable interest rates on houses will rise significantly in the event of an economic slowdown. Businesses and consumers will default on loans, triggering a collapse in the housing sector. Other signals of a looming crash suggested by Chancellor & Monnelly (2013) include widespread financial fraud and corruption, savings moving from state-owned banking system to non-bank credit instruments, increased off-shore banking and dubious lending practices and concealment of nonperforming loans.
Credit has always been the major source of investment funding and a monetary tool for managing shocks in the money market in China. This cash infusion into the banking system whenever money market rates rise has stabilized market interest rates at higher levels than in the past, and will keep on rising if the government continues with such course of action (Meijer2014). If the credit bubble is deflated early enough and growth rate lowered to a sustainable level, then an economic meltdown can be averted. Otherwise if lending continues at this breakneck speed, then a crash is inevitable as history has proven time and again.
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