Three somewhat different views seem to be emerging on China's likely fate over the next few months. There's of course the doomsday view in which economic slowdown is followed by an implosion of the financial system. The flight of capital that is underway intensifies as over-leveraged firms begin to default, the yuan goes into free fall and so on and so forth.
The second view is that China is certainly slowing down but this is, in part, the inevitable consequence of structural change as the economy moves away from manufacturing and export orientation to greater dependence on internal consumer demand and services, both of which are faring relatively well.
The problem of bad loans is definitely a cause for concern but in the quasi-capitalist system of China they have much more backing and support from the government than their free-market counterparts. As long as the Chinese government can raise funds, both domestically and abroad, it will throw its weight behind the banks. All this will prevent the cliched "hard landing" that many fear.
Besides, the housing sector, the favourite whipping boy of China-baiters, seems to be doing reasonably well. While new home constructions are down, home sales clocked 17 per cent growth in 2015, after a decline of eight per cent in 2014.
The third view is that even if a crisis were to precipitate in China, both the initial shock and its contagion would be very different from a typical bank-led financial crisis that we witnessed in 2008 in the US. For one thing, China's large banks' balance sheets still look fairly strong. This is not government propaganda. Global rating agencies like Moody's Investors Services rate all four of China's "big four" banks, each majority-owned by the government, still A1/stable - six notches above speculative grade and higher than all six of the top US banks, which are rated A2 or A3. The fact that these banks are largely funded by deposits, not wholesale funds borrowed from the money markets (as was the case in the US), and have reasonably large loan loss provisions also give them a degree of stability. The bottom line is that the "systemically important" Chinese banks seem fairly insulated from a crisis.
There is another important facet. A customised exercise done by Moody's analytics for the television channel CNBC shows that the link between China's larger financial institutions and the US banking system is weak. Besides, the direct exposures of the large American banks (the big six, among them Citibank) to China, both in terms of government and other bonds, is limited. In short, the risk of a quick contagion spreading from a financial crisis in China to the Western financial system is limited. Couple this with the fact that unlike the developed markets where the decision to bail a bank out is preceded by much hand-wringing and delay, the Chinese government is likely to provide an automatic backstop to its leading banks and a Lehman-like blowout and a deep-freeze in global interbank markets that followed seem unlikely.
All this could bring some cheer to those who fret about China. However, the fact that if a crisis does emerge, it would spread not through large institutions but through a mesh of links between smaller entities - both firms and financial intermediaries - has its own set of problems. The modes of transmission are likely to be unfamiliar and thus, prima facie, difficult to contain.
China, for instance, has a large "shadow banking" sector through which an entire spectrum of products ranging from wealth management to loans to smaller enterprises is channelled. Heaven knows what a bust in this grey market would look like. Securities firms are also under strain because of the stock market fiasco. Their collapse could lead to another panic in stock markets that would spill over to the rest of the world. There is also an enduring worry among the sceptics that Chinese banks are cooking their books and their balance sheets are actually far more fragile than they look and by implication the rating agencies are slipping up on their due diligence. China is unlikely to slip off the radar for a while to come.
Abheek Barua is chief economist, HDFC Bank. Bidisha Ganguly is principal economist, CII
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
