The Chinese government provides implicit or explicit guarantee to banks, enterprises, local governments, securities and housing markets, increasing leverage ratios in the investment sectors. In this backdrop, risks would rise as its economy slows down. With accumulating debt in recent years, I believe China should take steps in the next three to five years to deal with the “bubbles”.
China’s guarantee has misled investors and made them think the bubbles are normal with no effect on their returns. So, they would not worry about the bubbles bursting or any other consequence. High leverage ratio and overcapacity are thus created and called by observers as “China’s Guaranteed Bubble”.
The history has proved that every major economy has experienced at least one financial crisis. Low-quality investment plus mounting debts indicate that the economic bubbles in China would burst sooner or later. China still has three to five years’ time to use structural reform to avert the risks in economy. If the opportunity was lost, China’s economy would suffer from heavy losses. Given the size of its economy, once the bubbles burst, global economy and finance would be affected in a big way.
The Chinese government is now in dilemma. On the one hand, it hopes to allow some companies to default in bonds to end the expectation of “rigid repayment” and alert investors to do more risk assessment; on the other hand, the government could not just let it happen considering every default poses systemic risk to the financial system.
It’s not that policymakers have failed to identify the problems and they don’t know how to deal with the problems. However, with high leverage ratio and opaque system, “you cannot wake up somebody who is only pretending to sleep.”
There is a notable phenomenon that Chinese or Asian investors are more willing to take financial risks. In China, investors have been emboldened by government’s policy, capital and investment guarantee to take mounting risks and also expect higher returns. The sentiment has led to over-investment and bubbles in asset prices.
Government’s efforts to improve the fiscal, taxation, banking and legal systems are keys to eliminate the bubbles. I’m optimistic that the reforms would follow the right path and be carried out effectively.
Zhu Ning is vice president of the Shanghai Advanced Institute of Finance and professor of finance.
The article is translated by Rebecca Lin.