China’s accumulated bad debt has weakened its ability to revive growth through lending and government spending, according to remarks at the Brookings Institution’s “Is China’s economy broken” discussion, published Oct. 29.
The argument put the country’s difficulties beyond the ordinary slowdown of a maturing economy. The financial and fiscal tools that helped support its expansion now face limits because of the debts accumulated along the way.
“The tools that China has used in the past to generate economic growth and to control their economy, the fiscal and financial system, can no longer serve that function.”
Those tools helped finance an exceptional expansion of credit. China now faces the costs of investments that failed to pay off and debts that went bad, leaving the mechanisms that supported growth less able to sustain it.
The argument linked that accumulation of financial risk to efforts to contain political risk. Allowing debt to build helped avoid political difficulties at the time, but left costs that the economy must now absorb.
That distinction matters when assessing the government’s ability to manage the economy. An emerging economy at the start of a lending boom has different room to act from one already dealing with the consequences of such borrowing.
China’s credit expansion was described as among the largest recorded in a single country in at least a century. Authorities have tried to manage the subsequent decline by continuing loans to state-owned companies and local government financing vehicles, entities that borrow for local authorities.
The resulting difficulties have spread into government finances. Meanwhile, the economy has not shifted toward domestic consumption, leaving the usual responses to an economic downturn less effective.
“You can’t really expand the fiscal deficit considerably and you can’t ramp up the financial system.” The argument was that China had already exhausted the financial system’s capacity to support growth in that way.
Solutions remain available, but all would involve much slower growth while China reduces the recorded value of investments and decides who bears the losses. The remarks did not specify which solution authorities should choose, who should absorb those losses or how long the adjustment would take.
