China Saved the World in 2008 but now it’s About to do the Opposite

China Saved the World in 2008 but now it’s About to do the Opposite

China is getting the world’s attention again. Unfortunately, this time it’s for all the wrong reasons.

Earlier this month, shock waves rippled through the financial market after the Chinese overnight interbank lending rate – Shibor – surged to 8.29% from 5.98% literally overnight. Shibor is a useful proxy for liquidity in the Chinese credit markets and like Libor in Western markets, a sudden spike signals a reluctance between banks to lend to each other. ┬áThis could be for a multitude of reasons, but the one at the front of everyone’s mind is the imminent collapse of the Chinese credit markets under a colossal pile of debt.

These concerns were given foundations this weekend as the Chinese State Council requested a government debt audit, to try and establish how much debt local government bodies had taken on. The last time this audit was conducted was in 2010 and found that local bodies had $1.75 trillion of debt. Societe General estimates that the new audit will find that this figure has risen to $2.85 trillion – bear in mind local government debt in China only accounts for 12.3% of the country’s overall debt burden.

However, both government and local debt only accounts for 43.5% of China’s total leverage ratio of 221.4%. Corporate debt is the highest in the world, accounting for 151% of GDP during 2012, in comparison US corporate debt only accounts to 76% of GDP.

Moreover, debt is still growing at 15.1% annually, outpacing quarterly nominal GDP growth, which has fallen to 8%.

The Chinese deficit-to-GDP ratio has been running at around 5% for the past few years now but growing levels of debt around the country and instability in the banking system has cause the government to attempt to take action. A promise to reduce the deficit-to-GDP ratio to 3% will help but this comes at a time when the Western world is becoming increasingly worried about China’s outlook and extra economic stimulus could be required by the government; so cutting spending now could be a recipe for trouble.

There is no doubt that trouble is brewing in China.

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