China on verge of worst economic crisis in decades
September 4th, 2013
10:58 AM ET

China on verge of worst economic crisis in decades

Back in 2001, Goldman Sachs’ Jim O’Neill coined the term BRICs to describe the key fast growing developing economies of Brazil, Russia, India and China. But a dozen years later, is the focus on the BRICs misplaced? Indeed, is the group “broken,” as Morgan Stanley’s Ruchir Sharma has suggested?

“Although the world can expect more breakout nations to emerge from the bottom income tier, at the top and the middle, the new global economic order will probably look more like the old one than most observers predict,” Sharma wrote earlier this year. “The rest may continue to rise, but they will rise more slowly and unevenly than many experts are anticipating. And precious few will ever reach the income levels of the developed world.”

Each day this week, a leading analyst will assess the prospects of a BRIC nation and weigh in on whether it still deserves its place in a group of economic high flyers. Today, Minxin Pei looks at China, the only country that Sharma was relatively upbeat about.

By Minxin Pei, Special to CNN

Editor’s note: Minxin Pei is the Tom and Margot Pritzker ’72 Professor of Government at Claremont McKenna College and a non-resident senior fellow of the German Marshall Fund of the United States. The views expressed are his own.

Recent economic turmoil in major emerging market economies such as India, Indonesia, Turkey, Brazil, and South Africa has apparently made China, for all its economic woes, an oasis of stability.  Its currency, the renminbi, remains stable; its economic growth, though slowing down, is expected to reach 7 percent this year, the fastest among major economies.

But appearances are deceiving. Behind these statistics lies a far more fragile Chinese economic reality.  The relative calm of the Chinese economy actually conceals far greater risks.

The biggest short-term risk is financial overleveraging.  Thanks to its decade-long credit boom, the Chinese economy as a whole is far more leveraged (indebted) than any of the major emerging market economies. Net domestic credit as a share of GDP is close to 140 percent in China, compared with roughly 90 for Brazil, 75 for India, 60 for Turkey, and 35 for Indonesia.  To make matters worse, most of the debt is owed by state-owned companies, real estate developers, and local governments that are known for wasting capital on financially unprofitable investments.

More from CNN: Will China's economy crash?

For now, the bad debts incurred by these borrowers are not recognized on the balance sheet of Chinese banks, which are ordered by the Chinese government to roll over these loans. Estimates of bad loans hidden in Chinese banks vary, due to the opacity of the Chinese financial system. The most conservative estimates suggest they are around 10 percent to 15 percent of GDP. If that is true, the Chinese banking system is technically insolvent.

Thanks to its capital control and state ownership of banks, China does not face an imminent financial meltdown (since the government can maintain liquidity), but Chinese banks will have to be recapitalized at some point – an expensive, time-consuming and technically complex process that will have a substantial negative impact on future growth.

Even if Beijing manages, through a combination of inflation and clever accounting gimmicks (such as shifting bad loans to off-balance sheet financial entities), to make its banks healthy again, it has to confront a tough medium-term challenge: cutting China’s massive excess capacity in most industries.   Much of China’s investment, the most critical factor of its sustained rapid growth, has gone into manufacturing and infrastructure. As a result, excess capacity is plaguing major manufacturing industries (such as steel, cement, automobile, solar panel, wind turbines, and many others) and destroying profitability in sector after sector. To restore profitability and kill zombie firms that are now kept alive only by bank loans, China will have to shut down many companies – a politically difficult task.  More importantly, Beijing will have to follow up this painful restructuring with far-reaching financial sector reform so that investments in the future will not flow into sectors with excess capacity.

Whether China can deal with these two challenges is anybody’s guess.  However, one thing is clear –   mountainous bad loans hiding in the balance sheet of Chinese banks and massive overcapacity in its manufacturing industries are not going away. Even a successful resolution of these problems will unavoidably entail years of slower growth. Compared with other emerging economies, China’s problems are far bigger and more complex. They may appear manageable at the moment, but in the next one to two years, when the full magnitude of China’s macroeconomic risks and structural deficiencies are fully exposed, Beijing will likely face its most lethal economic crisis since the end of the Mao era.

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Topics: China • Economy

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soundoff (50 Responses)
  1. Really?

    Shouldn't the US debt crisis being more alarming, it's happening now. Why get into a frenzy about speculations.... I have more faith in Chinese banks than the ones that leeched of citizens of the world housed in the US.

    September 4, 2013 at 1:41 pm | Reply
  2. Maersk

    The writer should worry about the fact that he might have to zuck Chinese kwoks for a living instead.

    September 4, 2013 at 4:37 pm | Reply
  3. j. von hettlingen

    China's new government has ordered a national audit of government borrowing and announced that it is adopting a budget deficit limit of 3% of GDP, similar to the Maastricht Treaty's guidelines for the eurozone.

    September 5, 2013 at 9:46 am | Reply
    • j. von hettlingen

      China's gross debt-to-GDP ratio is said to be lower than the average debt level for advanced economies in the US and Europe, which is over 80%.

      September 5, 2013 at 9:47 am | Reply
      • Jared

        I'm not exactly sure where you are getting your info...China just does a better job at hiding its debt off the balance sheet because they are a lot less transparent than countries in the west. Real chinese debt-GDP is likely in the 90% range (and growing).

        Whats worrisome and often overlooked (for some strange reason) is Chinas corporate debt! China has the highest corporate debt in the world at 151% of GDP (and growing). Compare that to the US, where the corporate debt is roughly 70% of GDP. This means that a lot of chinese companies are insolvent. Most of these companies are stated owned utility companies.

        Suffice to say this article doesn't even begin to shed light on the true ills facing the Chinese economic juggernaut.

        September 5, 2013 at 8:41 pm |
    • Bill Rich

      That's strange. If there is no problem whatsoever with debt in Chinese government, why would the government ordered an audit at this time. Shouldn't audits on debt be done regularly, at least annually ? Doesn't the central government controls the local governments' finance, like how much they can borrow, and how much they can take in and spend ? Shouldn't these figures be reported regularly to the central government ? Or did the central government lost control over finances already ? Premier Li had, before he became Premier, said he would take the GDP reported from local government as "indicator" only, how much confidence does he has on the debt level reported by local government.

      And all these are just talking about government debts. How about corporate debts ? Chinese banks are ordered not to foreclose, and therefore had to continue to lend to cover interest payment for old debts. How big a problem is that ? Even state own enterprises, most have monopoly in the Chinese market, many of them have not made a profit for decades, and reflected in their share value in the market, how much did they borrow ?

      September 6, 2013 at 11:30 pm | Reply
  4. sardonic.veritas

    How many articles do we have to read about the sky falling down in China, before we begin to doubt the journalistic integrity of these news commentaries? i can hear the bombastic retorts as i type...this time it is different!

    These articles read more like a wish list of what some people would like to happen to China, rather then an economic forecast based on a balanced accounting of all the facts. It is not that these concerns are not's the exaggeration, and the untold other half of the story that make me feel like I am reading propaganda, ironic isn't it?

    I count my blessing I didn't heed these histrionic talking heads in the last decade, not only would I have lost every penny I own, I would not have made the money I did.

    The truth of the matter, economies from India to China and to the United States for that matter are more complex and are more faith-based rather than asset based that people would care to talk about.

    Every 101 macro-economic student knows that run on banks happen when people lose faith...maybe that's the reason for the sheer volume of stories like these.

    September 5, 2013 at 1:41 pm | Reply
    • ChasL

      Yeah, worst ever, a mere 7% growth we'd kill for.

      September 5, 2013 at 1:56 pm | Reply

      do anyone know the amount of debt carried by 80% of the listed indian corporates ,about 60% of these companies have turned into nett loss making company quarter on quarter, about 90% of these loans have been dolled out by state owned banks ,ever heard of CDR or corporate debt restructuring ,thats INDIAN ECONOMY !!!!!

      September 12, 2013 at 8:57 am | Reply
  5. abdocoo

    Teach English to children without a teacher

    September 5, 2013 at 5:38 pm | Reply
  6. Woodoo analyst

    That's what happened when commend economy is overriding market economy. Instead of letting the market dictates what to invest, it let administrative to allocate resources at different levels of government. As a result, excessive capacity happened and the only way to make return of the investment is to dump the products oversea. China economy is ill that appear healthy. But this wouldn't last particularly the demand in the world market recess and there is only so much of the capacity to obsorb the excess that eventually it wouldn't run into dead end.

    September 5, 2013 at 11:55 pm | Reply
  7. Davidake

    Most western people who adjust Chinese economy have forgot one important thing. China is still a socialist country (not communist anymore) which has look after its mass, especially poor mass. This is why a lot of state owned companies are still running even they loose money. As long as these large companies can keep their working force (poor mass), they will stay. This is why they are called state owned because state look after them. The purpose of exiting of these large state companies (especially large steel companies) are not make profit but keep the people employed. Same applies to Chinese big banks. The banks can loose money as long as the moneys go to country's infrastructures such as railway, road, airport and so on. Govt can easily wipe out all debts created by the big banks. In the last three decades, this has worked very well for China. The measure for juging the performance on the western world is not suitable to juge Chinese. If you guys do not know this, you will be always wrong on juging/predicting China's economy. Even I am not an economist, I can see this. Why your guys so called economists can not see this?

    September 6, 2013 at 3:06 am | Reply
  8. Jabulani Dhliwayo

    We should not overlook the impact of imperialism on the potential greatness of China. Once upon a time, small European nations became powerful through colonization. By plundering natural resources in Africa in unfair exchange for infrastructure development China’s economy will most likely be boosted. China has also been able to monopolize the African market for many of their products, including telecommunication equipment.

    September 10, 2013 at 1:28 am | Reply
  9. desert voice

    Better now than later. The moment has come to start fabricating a million portable soup kitchens to save China from massive starvation during oncoming Great Depression ! Each kitchen should be provided with canned non perishable food. The soup kitchens need to be purchased by China in advance. They need to be ready to pacify the population when the hunger begins. America has the technology to accomplish this grandiose project of saving China! The contracts should be signed now so people can be put to work!

    September 20, 2013 at 4:43 pm | Reply
  10. Brett Champion

    It's the same story as happened in the US, except the perpetrators in China are state-owned enterprises and government officials instead of consumers. Borrowing money can duo two things for an economy: it can either create more economic activity or it can merely bring forward future economic activity. The former is what intelligent investment is made of. The latter if what impatience and economic crises are made of.

    September 20, 2013 at 8:08 pm | Reply
  11. Miyamoto

    The economic statistics of the Chinese government are inaccurate.
    It is not a thing of a reliable level.
    The expanding war expenditure and bad loans will ruin Chinese economy.

    September 29, 2013 at 7:48 am | Reply

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