High political stakes as Chinese economy faces hard landing
Indeed, a recent study by Nomura Securities finds that China's financial-risk profile today uncannily resembles those of Thailand, Japan, Spain, and the US on the eve of their financial crises. Each crisis-hit economy had increased its financial leverage - the ratio of domestic credit to GDP - by 30 percentage points over five years shortly before their credit bubbles popped.
Economists who insist that China's financial leverage is not too high are a dwindling minority. The People's Bank of China, which engineered a credit squeeze in June to discourage loan growth, seems to believe that financial leverage has risen to dangerous levels. The only questions now concern when and how deleveraging will occur.
At the moment, China watchers are focusing on two scenarios. Under the first, a soft economic landing occurs after China's new leadership adopts ingenious policies to curb credit growth (especially through the shadow banking system), forces over-leveraged borrowers into bankruptcy, and injects fiscal resources into the banking system to shore up its capital base. China's GDP growth, which relies heavily on credit, will take a hit. But the deleveraging process will be gradual and orderly.
Under the second scenario, China's leaders fail to rein in credit growth, mainly because highly leveraged local governments, well-connected real-estate developers, and state-owned enterprises successfully resist policies that would cut off their access to financing and force them into insolvency. Consequently, credit growth remains unchecked until an unforeseen event triggers China's "Lehman" moment. Should this happen, growth will collapse, many borrowers will default, and financial chaos could ensue.
Two intriguing observations emerge. First, drastic financial deleveraging is unavoidable. Second, Chinese growth will fall under either scenario.
What impact will an era of financial deleveraging and decelerating growth have on Chinese politics?
Most would suggest that a period of financial retrenchment and slow GDP growth poses a serious threat to the Chinese Communist Party (CCP), which is based on economic performance. Rising unemployment could spur social unrest. The middle class might turn against the party. Because economic distress harms different social groups simultaneously, it could facilitate the emergence of a broad anti-CCP coalition.
The people who should be most concerned with financial deleveraging and slower growth are President and CCP General Secretary Xi Jinping and Prime Minister Li Keqiang. If the deleveraging process is quick and orderly, they will emerge stronger in time for their reappointment in 2017.
Frequently Asked Questions about this Article…
A "China hard landing" refers to a sharp slowdown or collapse in China's economic growth driven by financial stress — for example, the recent spike in interbank loan rates to double digits. In the article's context, it means a rapid deleveraging of the economy after years of massive credit growth and rising financial leverage, which could push growth down quickly and increase market volatility that everyday investors should monitor.
The turmoil was fuelled by years of massive credit growth — roughly the equivalent of 30% of GDP from 2008 to 2012 — which pushed China's financial leverage to the highest level among emerging markets. That high leverage, combined with a credit squeeze engineered by the People’s Bank of China, produced sharp stress such as interbank loan rates jumping into double digits.
The article outlines two scenarios: (1) a soft landing where new leadership curbs credit growth (including shadow banking), forces over‑leveraged borrowers into bankruptcy, and uses fiscal resources to shore up banks — leading to a gradual, orderly deleveraging and slower GDP growth; or (2) a failed rein‑in where local governments, property developers and state firms resist and credit keeps rising until an unforeseen shock triggers a Lehman‑type crisis, causing collapse in growth and widespread defaults.
According to the article, drastic financial deleveraging appears unavoidable. Importantly, Chinese growth is expected to fall under either the orderly (soft) or disorderly (hard) deleveraging scenarios. The timing and shape of the decline remain uncertain, but a period of slower growth is presented as likely.
Investors should watch indicators cited in the article such as interbank loan rates, overall credit growth (ratio of domestic credit to GDP), regulatory moves by the People’s Bank of China, activity in the shadow banking sector, signs of borrower defaults, and any fiscal injections or capital support for banks.
The article warns that a sharp deleveraging or a sudden crisis in China would lead to collapsing growth and potential financial chaos domestically. While not detailed in the piece, that outcome typically raises global market volatility and can affect trade, commodity demand and investor risk sentiment — so investors often watch China closely because of its role as the world’s second‑largest economy.
A period of retrenchment and slower GDP growth poses a serious political risk to the Chinese Communist Party, which derives legitimacy from economic performance. The article notes risks such as rising unemployment, social unrest, and the middle class turning against the party — all of which could threaten the standing of President Xi Jinping and Premier Li Keqiang, especially ahead of leadership appointments.
Based on the article’s emphasis on inevitable deleveraging and slower growth, everyday investors should stay informed about China’s credit indicators and PBOC policy moves, review and diversify exposure to China‑sensitive assets, and be prepared for increased volatility. The article highlights uncertainty about timing and severity, so a cautious, well‑informed approach is sensible.
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