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China’s Credit Overdose

Despite rapid credit expansion in the last two years, China's GDP growth has decelerated sharply. This disparity reflects the accumulation of massive debts, which require an ever-increasing amount of liquidity to service.

SHANGHAI – The days of double-digit economic growth in China are over. Indeed, the annual growth rate, which has been lingering at about 7.5% since 2012, is predicted to fall to 7% this year – and is likely to go lower. This is China’s “new normal,” characterized, according to China’s leaders, by “medium-to-high-speed” (instead of high-speed) growth. But perhaps even this is optimistic.

In the last two years, credit grew almost twice as fast as GDP, and total social financing grew even faster. Yet GDP growth slowed considerably – from an annual average of 10.2% in 2002-2011 – suggesting that China may be moving closer to a medium-to-low-speed growth path.

One possible explanation for the divergence between credit and GDP growth is that potential growth has already dropped to 7%. But such a sharp decline in potential growth typically implies a powerful brake, in the form of an external shock or major internal adjustments. Under normal circumstances, an economy’s potential growth rate adjusts naturally and gradually, as structural change progresses.

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