Financial strains put China's economy in jeopardy

Subject

The risk of a financial crisis in China.

Significance

A number of scenarios currently playing out in China's financial system have the potential to trigger a financial crisis. Most pressing among these, as with any crisis, is the leverage and its potential to aggravate other factors, especially off-balance-sheet financing. A subtle state-led restructuring of debt is already under way, indicating that officials have grasped some of the lessons of a previous bailout. While this lessens the immediate possibility of a financial crisis, its scale is inadequate to deal with the consequences of the debt overhang.

Impacts

• Currency liberalisation and structural reforms will be postponed in favour of stability.
• Bad loans are unlikely to reach 1990s levels, but the debt overhang will retard economic growth.
• Poor corporate governance practices and a failure to reform stock markets will hinder debt restructuring.
• The fiscal cost of a bailout, were one necessary, would be prolonged over several years, as in the 1998 case.