Credit and Credibility: Risks to China’s Economic Resilience
Credit and Credibility examines China's epic growth performance to date, and why it is running out of steam. China's leaders permitted the largest credit expansion worldwide of the past 100 years so far without a financial crisis or reporting an abrupt growth slowdown. The study explains China's unusual resilience and the key risks ahead. This marathon growth depended on record-breaking financial system expansion, which in turn required monetary and regulatory laxity. Inevitably, this has created systemic risk, causing Beijing to respond with an aggressive deleveraging campaign which today puts growth as we've known it deeply in doubt.
Most explanations of China's resilience focus on economic factors: a high national savings rate and a low level of external debt. Other analyses stress administrative control over key institutions. These explanations underplay the most critical factor: Beijing's ability to respond credibly to any instance of financial stress that results from this debt-driven strategy. Credibility has been the crucial bulwark of financial stability, but it is not intrinsic to China's system. Credibility is a byproduct of a long track record of responses to distress, but it will be severely strained by a gathering swell of necessary reforms, forcing Beijing to disavow many implicit and explicit asset, company, and bank guarantees that were presumed to be reliable in the past.
The bargain between China's leadership and led—households and investors—is changing because Beijing cannot for long assure stability for an increasingly risky and complex system as its credibility is stretched thin. In addition to implications for Beijing's policy options and likely path forward, this analysis has implications for how the United States and other advanced economies should prepare for a riskier outlook for China's economy.
Logan Wright is director of China Markets Research at Rhodium Group and an adjunct fellow of the Freeman Chair in China Studies at the Center for Strategic and International Studies (CSIS). Daniel H. Rosen is the founding partner of Rhodium Group and leads the firm’s work on China.