China’s Credit Overdose

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.

In fact, there is no definitive evidence that China’s potential growth rate has plunged. China weathered the 2008 global economic crisis better than other emerging economies. And, though structural factors, including an aging population and shrinking labor force, can certainly undermine potential growth, their effects are not sudden.