Risk lessons to be learnt from China

02:30, Nov 09 2012

If you believe bad things happen in threes, China's economy offers plenty of risks to chew on, says Infometrics economist Gareth Kiernan.

The managing director of the economics consultancy told a PwC-hosted seminar in Hamilton that with China's slowing economic growth causing concern, the question was, could it be the next problem economy after the US and Europe?

For that to happen bad loans would have to appear on China's balance sheet and that was not out of the question, he said.

There had been overemphasis on exports by China and over-investment in this sector.

"Demand growth from the rest of the world has weakened and some of those poor decisions could start appearing on bank balance sheets, " Kiernan said.

China's local government was highly indebted, its spending adding 6 per cent to GDP over the past two years. Local government debt was 28 per cent of China's GDP. New Zealand's was estimated to peak at 30-40 per cent, he said.

The reason bad loans were not appearing yet was because China's banks were rolling them over.

"So there is real risk there for bailouts."

The wealth of Chinese households was lower than previously, Kiernan said.

Another threat is what is known as China's "shadow banking sector".

In this sector are non-bank lending institutions, many "pretty dodgy", he said.

There were 62 "investment trusts" within the shadow sector, 10 of them accounting for half of the loans. The shadow sector made up 2.5 per cent of China's financial sector, which may not sound a lot but represented $460 billion of lending, more than twice New Zealand's GDP, he said.

Lending was generally of low quality, with many of the trusts lending to each other and to poor quality property development.

"Defaults by low tier developers and the shadow banking sector would hit the core financial system. So there are a number of risks," Kiernan said.

China's anticipated growth was 8 per cent for each of the next two years, he said.

"But keep an eye on it, if it does fall over it will be a pretty ugly picture."

Another impact on China's economy would be its ageing population.

While projections were based on China's present one-child policy and could change if this was relaxed, by 2070 it was expected that 30 per cent of the population would be over 65 years old. But it would only be 15 to 20 years before the over-65 demographic rose "dramatically".

"A huge lift (in over 65-year-olds) is a real change coming through for the Chinese economy. Savings rates will decline and as the size of the the proportion of this population increases there will be more pressure on the government to introduce a welfare safety net and for other groups as well.

As international credit became constrained, there would be a potentially negative effect on China's property market.

Less credit availability would presumably push up retail interest rates.

"This would not be entirely bad...higher interest rates would bring higher quality investments but could certainly be expected to constrain growth."

Upward pressure on the Chinese yuan would push up exchange rates putting pressure on Chinese exporters, Kiernan said.

One of China biggest advantages, it's pool of very cheap labour would start to be eroded over the medium term and exporting would get tougher, he said.