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Asia Economy Last Updated: Apr 30, 2014 - 6:15 PM

Three reasons why a full-blown Chinese economic crisis is unlikely
By Michael Hennigan, Finfacts founder and editor
Apr 29, 2014 - 10:04 AM

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The International Monetary Fund on Monday raised its economic growth forecast for China but warned that its financial system faces risks due to the rapid expansion of debt. However, the Fund's Asia director gave three reasons why a full-blown economic crisis is unlikely.

The IMF raised its growth forecast for China by a 0.3 percentage point increase to 7.5% while projecting that growth in Asia is projected to remain steady at 5.4% in 2014 and 5.5% in 2015 [pdf].

Changyong Rhee, director of the IMF’s Asia and Pacific Department, in an interview with The Wall Street Journal said:

1. China’s owes most of its debt to itself. China’s total foreign debt amounts to only about 9% of its GDP, while South Korea’s was roughly one-third of GDP back in 1997.

Rhee says China is set to have a rising number of credit defaults but it will not likely see a rerun of the Asian financial crisis of 1997/1998.

2. China’s government debt is low. The annual budget deficit is about 2.1% of GDP and total public debt, both owed by the national government and China’s much more heavily indebted local governments, at about 53% of GDP, remains low compared with Japan's gross public debt of about 240% of GDP.

“If something bad happens, they will muddle through,” said Rhee said.

3. China’s slowdown, like its economy, is central planned. The Communist Party leadership has more leeway to manage the economy than democratic governments.

It directly controls the central bank.

Rhee said 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. Developing insurance for bank deposits, he said, will help cut 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,” 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 micro remedies to stem financial contagion.

Last week, Nicholas Borst of the Washington DC-based Peterson Institute for International Economics wrote: "China is currently undergoing a new round of bank stress testing, with a drop in real estate prices certain to be amongst the variables tested. Previous stress tests, both official and unofficial, have downplayed the risks to the banks from a housing price downturn.  For example, a recent report from the Bank of Communications Financial Research Center estimated that a decline in housing prices by less than 30% would have little to no impact on the non-performing loan (NPL) ratio in the banking system. Even a larger price drop of 40 to 50% would only increase the NPL ratio by 3.8 to 5.6 percentage points."

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