China's economic stability comes with hidden costs

china vice president li yuanchao Li Jianchao, Vice-President of China attends a session during the Annual Meeting 2016 of the World Economic Forum (WEF) in Davos, Switzerland January 21, 2016. Reuters

Remember when China’s economic crash was imminent and ready to take down the rest of the world with it?

Those concerns, which peaked with the 2015 crash of the Chinese stock market, have since receded, giving way to more subtle worries about the country’s sky-rocketing corporate debt levels — and an eventual day of reckoning.

This uneasy calm is reflected in the International Monetary Fund’s latest outlook on the world’s second largest economy.

"China continues to enjoy strong growth—projected at 6.7% for 2017. And the country has potential to sustain strong growth over the medium term,"  the Fund said its latest assessment of China’s economy, dated Aug. 15. "But to do so safely requires speeding up reforms to make growth less reliant on debt and investment."

The following six charts capture the dynamic of fragile, debt-fueled stability:

Stronger outlook for economic growth

Stronger outlook for economic growth
International Monetary Fund

IMF staff have become more upbeat on China’s growth outlook compared to last year’s report. Growth between 2017 and 2021 for the world’s second largest economy is now expected to average 6.4%, up from 6.0% in last year’s forecast.

Rising debt load

Rising debt load
IMF

Stronger growth prospects come at the cost of higher debt levels, a key concern for China. The country's total non-financial sector debt—which includes household, corporate and government debt—will surge to nearly 300% of GDP by 2022, up from 242% in 2016. "This raises concerns for a possible sharp decline in growth in the medium term," the Fund says.

Time to deleverage

Time to deleverage
IMF

The IMF says China should seize on the strong growth backdrop to force reductions in corporate debt levels. "The Chinese government has started to take important initial steps to facilitate private sector deleveraging—credit growth is slowing and the large 'credit gap' is narrowing. These efforts should intensify," the Fund says.

Consumer spending key to sustainability

Consumer spending key to sustainability
IMF

The IMF echoes a long-standing concern of Western economists — a lack of sufficient domestic consumption in China for an economy its size. "To grow strongly, but also sustainably, China needs to boost consumption. At 46% of GDP, China’s national savings are 26 percentage points higher than the global average, largely due to the household sector, with consumption correspondingly low."

Social spending lags

Social spending lags
IMF

One of the reasons for the lack of consumption is that the absence of a social safety net forces Chinese families to sock away more money for health expenses and retirement than their Western counterparts.

Boosting productivity

Boosting productivity
IMF

China's economy could also benefit from higher productivity, the IMF says. "This can be done by making better use of resources that are currently going to loss-making (“zombie”) companies, overcapacity industries, and State-Owned Enterprises (SOEs)," the Fund says, estimating this alone could raise the contribution of productivity to growth by about 1 percentage point over the long term.

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