On May 24 Moody’s Investor Services downgraded China’s debt for the first time since 1989 to A1 from Aa3.
This is still investment grade, but just a lower rating, and is due to a rise in credit extension, which has surged to the equivalent of 260percent of the economy at the end of 2016 from 160percent in 2008.
As China is South Africa’s largest trading partner, what happens in China could have a material impact on South Africa’s export prospects with recent volatility in iron ore prices at Chinese ports highlighting our dependency on the world’s second largest economy.
The dependency on China is not only a potential problem for South Africa, but for the rest of the world as well, as China contributed 43percent of the rise in global product in 2016, while the world’s largest economy, the US, only contributed 17percent.
It has been almost two decades since the US had the same relative contribution to global growth that China has today as it was in the wake of the 1997-98 Asian currency crisis that the US contributed 45percent to global growth.
Global impact
In August 2015 and January 2016, a yuan devaluation and a credit tightening respectively had a global impact. In the first episode, most equity markets lost than 5percent in the week subsequent to the devaluation, while in the second episode, China’s Shanghai composite index crashed more than 24percent and most other equity markets, including the JSE and S&P 500 fell more than 10percent.
This caused the US central bank, which raised rates in December 2015 and had planned on four hikes in 2016, to back off monetary policy tightening and it only raised rates again in December 2016.
Chinese credit has been growing twice as fast as nominal gross domestic product since the 2008 global financial crisis.
The diminishing returns on credit suggest that many loans are going to unprofitable ventures, such as apartments that are never occupied.
They may also signal that sustainable economic growth is far less than current growth rates above 6percent, but rather closer to 3percent.
Currently the Chinese central bank has limited some liquidity, while municipal regulators are enacting new rules on the percentage of deposits required for first and second homes to limit housing demand.
Authorities are also trying to rein in the massive wealth management investments that are held off banks’ balance sheets and are fuelling the so-called “shadow” banking system.
China’s M2 money supply has doubled in six years from 80trillion yuan (R150trln) in 2011 to 160trln yuan currently.