Is China setting itself up for a credit bust?

July 16th, 2009

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Today, China posted an impressive 7.9% GDP growth in the 3 months to June 2009. The most commonly accepted reasons for such a rapid revival in growth are:

  1. 4 trillion yuan stimulus package
  2. Relaxation of lending standards for banks

No doubt, this gives the markets plenty of reasons to be optimistic about the world economy. Economic figures for housing and autos seem to point to a strong recovery in China. Yet on the other hand, there are many other contradictory economic signals as well. For example, Chinese exports are falling for 8 months straight (see China’s exports sink 21%). Consumer prices fell 1.7% in June (see China’s June CPI falls 1.7%). Producer prices fell 7.8% in June (see China’s PPI falls 7.8% in June).

The biggest concern we have for China right now is the surging growth in lending. Take a look at China’s lending growth over the past 3 years:

China's credit growth 2006 to H1 2009

As you can see, bank lending in China surged in 2009. As the Chines economy slowed significantly, it is very likely that private demand for debt will decline significantly too. What do you think will happen if the Chinese government force feed even more credit into the economy? Chances are, a lot of these credit will leak into speculations, unproductive projects and mal-investments.

This is a recipe for exploding amount of bad debts in the near future.

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