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China vulnerabilities “dangerous”, says IMF

Despite China’s notable reform progress, areas such as excessive corporate debt and tightening the fiscal screws on state-owned enterprises are critical issues in the medium-term, according to an August report on China from the IMF.

“Reforms have advanced impressively across a wide domain, but lagged in some critical areas, and the transition to sustainable growth is proving difficult, with sizable economic and financial volatility.

“Vulnerabilities are rising on a dangerous trajectory and buffers, while still adequate, are eroding.

“Under staff’s baseline scenario, growth will decline below 6 percent over the medium term, the credit/GDP ratio will continue rising, and the risks of a disruptive adjustment will increase.”

A core issue is that growth is driven by shadow financing, which includes onshore wealth management products, according to Logan Wright at research firm Rhodium Group, who was interviewed in a Bloomberg report.

“The nation has at most about 18 months before this funding [of GDP growth] — derived largely from wealth-management products offering higher returns on riskier underlying investments — hits a wall,” according to Wright.

“It’s pretty shocking just how important this has become and how the funding structures for this type of asset creation have changed,” he said. “Everyone assumes it’s a stable system, it’s deposit-funded. It’s just not true any more.”

In the report, Wright also compared the financial engineering used to generate credit needed to fuel GDP growth to the creation of the complex financial products that sparked the global financial crisis in 2007-2008.

According to the IMF, China’s banks held RMB 15.2tn ($2.28trn) of shadow banking products on their balance sheets at the end of 2015. The figure has spiked 58% year-on-year for listed banks. It is equivalent to 8% of banks’ assets and 92% of capital buffers. 

China has been cracking down on P2P lending, a form of shadow banking. Yesterday, the CSRC announced new rules that prohibit P2P lending platforms from selling wealth management products and from taking deposits, according to a Reuters report. It also imposed limits on borrowing.

There are currently about 3000 P2P lending firms in China, but this number will likely be trimmed to 300 in a year’s time, the report said.

Drew Wilson

Drew Wilson is editor of Fund Selector Asia. Previously he was editor at a publication covering private equity.

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