China's economic growth is slowing, property prices in some smaller cities are declining and some companies are starting to default. But Changyong Rhee, director of the International Monetary Fund's Asia and Pacific Department, believes the odds of China suffering a full-blown financial crisis remain low.
In an interview, Mr. Rhee outlined a number of reason not to sound the alarm bells:
1. China's owes most of its debt to itself. True, China's debt -- some tallies put the sum of private and government debt at double China's gross domestic product -- is scary. How companies and local governments will manage to service that debt as growth cools and interest rates rise is a puzzler. The IMF's latest Regional Economic Outlook, released Monday, predicts China's economic growth will slow to 7.5% this year from 7.7% last year, then further to 7.3% in 2015.
Mr. Rhee says China is bound to see a rising number of credit defaults. But unlike Thailand or South Korea before the Asian financial crisis erupted in 1997, China hasn't borrowed heavily abroad in foreign currencies. China's total foreign debt amounts to only about 9% of its GDP, according to the country's foreign-exchange regulator. South Korea's was roughly one-third of GDP back in 1997.
That means that if China's currency falls further (it has dropped roughly 3% so far this year), it won't necessarily cause a dramatic increase in borrowers' debts in local-currency terms that then causes bankruptcies to snowball.
2. China's government debt is low. Like many governments in advanced economies, Beijing runs a budget deficit. But that deficit is relatively small -- about 2.1% of GDP. And total government debt, both those owed by the national government and China's much more heavily indebted provinces, still add up to only about 53% of GDP, according to Bank of America Merrill Lynch. Compare that with the U.S., where government debt is roughly as big as GDP, or Japan, where government debt has ballooned to roughly 240% of GDP.
That means China can afford to spend more to offset the economic slowdown if it becomes too painful to borrowers. It can even afford to bail out banks or borrowers it deems too big to fail. In the worst case scenario, China's central bank can follow the lead of the U.S. Federal Reserve and the Bank of Japan and create money by buying up assets -- a policy known as quantitative easing. 'If something bad happens, they will muddle through,' said Mr. Rhee.
3. China's slowdown, like its economy, is central planned. While it's easy to overestimate the degree of control Communist Party leaders have over economic decision making on the ground, they nonetheless are able to exert their influence in a way that policy makers in the United States and other democratic nations can only envy.
The U.S. Congress rebuffed former Treasury Secretary Henry Paulson's first plan for halting the financial crisis in late-2008. China's economic mandarins have much wider latitude to implement policy without the say-so of China's National People's Congress. Most of the country's banks are state-controlled and state-run companies still dominate the economy.
China can instruct banks how to lend and to whom, and can even tell big companies how and where to invest. That's a solution China's leaders seem eager to avoid, but it remains an option. On the contrary, central bankers in the U.S. and Europe have found that even record-low interest rates could not compel banks to lend or companies to borrow, a situation that made their economic crises worse.
Does that mean China can sit back and do nothing? Absolutely not, said Mr. Rhee. China needs to stay the course of overhauling its economy to reduce its reliance on exports and investment in property and heavy industry.
China also needs to keep withdrawing cash from its economy to gradually push up interest rates and deflate its credit bubble, Mr. Rhee said. Developing insurance for bank deposits, he said, will help reduce the widespread misperception in China that the government stands ready to bail out any borrower. That myth has helped encourage excessive lending, both by banks and the unregulated non-bank financial sector -- so-called shadow banks.
'The process will be bumpy,' Mr. Rhee warned. Defaults are inevitable. But rather than unleash a wave of new credit as China did in 2008 to offset a global slowdown, China should rely on small remedies - 'micro-surgery' as Mr. Rhee put it - to stem financial contagion.