Richard Koo of the Nomura Research Institute says the country is likely to face such a situation “given what’s happening to the asset markets.”…(read more)

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China is likely to face a ‘balance sheet recession,’ economist says

In the wake of the global financial crisis in 2008, many developed economies experienced what is known as a ‘balance sheet recession.’ Now, it seems that China is at risk of facing a similar situation, according to a prominent economist.

A balance sheet recession occurs when individuals, companies, and governments focus on reducing debt levels rather than engaging in new spending. This behavior can lead to a decline in economic activity, slow growth, and a prolonged period of stagnation.

The concern arises from China’s significant debt buildup over the past decade. In an effort to sustain high growth rates, the Chinese government encouraged massive borrowing, particularly by state-owned enterprises (SOEs) and local governments. As a result, China’s total debt reached an alarming 317% of GDP by the end of 2020, making it one of the most indebted countries in the world.

What makes the situation more challenging is that China’s debt problem is not limited to just a few sectors or companies. It is pervasive and deeply rooted. Many of the loans extended to SOEs, for instance, are of low quality and carry higher risks, which could lead to potential defaults. This, in turn, could have a cascading effect on the broader economy.

The economist argues that China’s focus on deleveraging, reducing debt, and overhauling its financial system has already slowed down economic growth, and if it continues, it could lead to a balance sheet recession. The government’s push to reduce risks in the financial system has resulted in a credit crunch, with banks tightening lending standards, which further hampers economic activity.

The impact of a balance sheet recession in China would have significant implications globally. China is the world’s second-largest economy and a major driver of global growth. A contraction in Chinese economic activity would have far-reaching consequences on international markets, trade, and commodity prices.

Moreover, a balance sheet recession could undermine the Chinese government’s efforts to achieve its goal of becoming a high-income country by 2025. With reduced economic activity, it will become increasingly challenging for China to generate the necessary income to sustain its growth ambitions.

To mitigate the risk of a balance sheet recession, the economist suggests that China needs to strike a delicate balance between reducing debt levels and maintaining economic growth. The government needs to target specific sectors that are most vulnerable to defaults and ensure they are adequately supported. Additionally, improving the efficiency of the financial system and addressing governance issues within SOEs can help reduce systemic risks and restore investor confidence.

It is important for China to heed these warnings and take proactive measures to prevent a balance sheet recession. The world is watching, as the resilience and stability of the Chinese economy have a significant impact on the global economic landscape.