[Submission Date]
This paper is written to present a short summary of an article titled “The coming debt bust” that was published on 7th May 2016 in a magazine named “The Economist.” The article presents the concrete reasons for which the Chinese economy has been facing financial troubles. Such problems may continue to rise if the prevailing financial situation (concerning debt and lending practices) in China is not controlled to an optimum level.
The article presents that after the global financial and economic crisis of 2008, China’s debt level increased where the debt-to-GDP ratio increased to an alarming level of 150% to 260% within a period of ten years that confirms that the Chinese economy is slowing down due to a financial bust.
Mismanagement in debt and lending activities have caused more than 160 Chinese firms out of 1000 organizations to lose their profitability since a larger portion of their revenue was eaten up by rising debt levels and interest cost. In this situation, Chinese economy and firms are in greater need of additional lending to generate growth prospects and sustainable profits. The article confirms that the Chinese economy borrows Four Yuan in order to generate an economic output (GDP) of One Yuan.
The concerns are serious because Chinese assets account for 40% of its GDP. After American Stock markets, the one in China is worth $6 trillion in value while its bond securities market make-up the third largest market worldwide with a value of $7.5 trillion. To the world, China stands a major trade partner
Over the years, The Chinese policymakers had two policy measures for dealing with any financial and economic trouble beforehand. First, they had the will and skill needed to deal with any problem right after identifying it. With the passage of time, China’s policymakers are losing their will to deal with issues ahead. Moreover, since most of the banks are owned by the state, debtors used to provide relaxed credit term which is no longer available these days.
The current issues of China’s economy are serious from financial perspective since the economy has lost an investment of around $600 billion and $65 billion of bank loans have become bad-debts since they remain unrecoverable while the Chinese financial system had to inject $200 billion to support the recent stock market crash at start of 2016.
There are financial reasons for which Chinese banks are losing their liquidity and profits. This is true because the article communicates that these banks remain hungry for earning higher than expected profits. Due to this, they make the mistake of considering their risky loans as their investments. While everyone in China is witnessing financial issues, citizens’ ability to repay is badly hurt that increases the bank losses.
The article also presents the prime reason for which China’s banking sector is in continuous pressure is because it is heavily reliant on paying higher interest rate on “short-term” deposits and is extending loan for “long-term” tenure. This is why; banks in China are facing maturity mismatch. The increase in cash reserve requirement from less than 75% to 100% has also pressurized the banking industry .
References
TE. (2016, May 7). The coming debt bust. Retrieved February 1, 2017, from The Economist: http://www.economist.com/news/leaders/21698240-it-question-when-not-if-real-trouble-will-hit-china-coming-debt-bust
