China’s Risky Credit Boom

Credit in China is growing at a breakneck pace, raising serious concerns about the level of risk in the financial system. The government now must determine how to balance the economy’s liquidity needs with protecting the system's solvency.

HONG KONG – Credit in China is growing at a breakneck pace, having increased from 125% of GDP in 2008 to 215% in 2012. Local-government debt has soared by 70% since 2009, reaching almost $3 trillion last June. This is raising serious concerns about the level of risk in China’s financial system.

China’s rapid credit growth reflects the government’s move to loosen restrictions on investment, as well as very low interest rates in the formal banking sector. Since 2000, the one-year fixed-term deposit rate in China has remained in the 2-4% range, roughly equal to the consumer inflation rate. The lending rate in the formal banking system – which provides credit mostly to state-owned enterprises (SOEs), urban mortgage borrowers, and government projects – has also remained relatively stable, at 5.5-7%.

Unsurprisingly, the combination of easy credit, low official rates, and high demand caused property prices to surge by 300-500% in some Chinese cities over the last decade. This has led to broad-based wealth distribution, with 80% of urban households owning their homes. But access to cheap credit remains a privilege reserved for a select group, which has amassed property and real estate, while new entrants to the labor market and small and medium-size enterprises have struggled to acquire credit at reasonable rates.

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