The outgoing chairman of the People’s Bank of China, Zhou Xiaochuan, dropped a bombshell at the Communist Party congress last week when he said that China could be headed for a ‘Minsky moment’, rattling markets the world over. The late economist Hyman Minsky had presciently said that periods of high growth and stability generate overconfidence and a rash of speculative activity promoted by the banking system, triggering periodic financial crises, such as the 2008 meltdown. China’s total debt, household and corporate, is more than three times its GDP. To place this in perspective, the US’ total debt as a proportion of GDP was about 170 per cent (against China’s well over 200 per cent today) when the Lehman crisis broke out. According to a report by Crescat Capital, the value of financial assets held by households and non-profit organisations in China is over six times their disposable income, similar to the levels seen during the 2007 housing bubble in the US and the dotcom bust of the late 1990s. China’s banks waded through the post-2008 slowdown by creating more debt to generate a rash of infrastructure assets whose productivity was low. Meanwhile, a shadow banking system is flourishing in China as a huge Ponzi operation (debt is used to pay debt when cash flows neither cover principal nor interest). Equities and the real estate markets are frothy. China’s elites are already taking their money out of the country. If the crisis intensifies, China may resort to quantitative easing to clean up balance sheets, where non-performing loans could make up over a fifth of the assets. A spurt in money supply could lead to depreciation of the currency. Even if an outright crash is somehow avoided (a state-run banking system may be able to control outcomes somewhat), the world should be prepared for a tremor more intense than in August 2015, when the renminbi was sharply devalued.
When an economy that accounts for 15 per cent of world GDP, 13 per cent of global exports and 10 per cent of global imports hits a speedbreaker it is bound to impact the rest of the world, including India. India shouldn’t assume, as it did two years ago, that China’s loss would be its gain. A cheaper yuan may impact India’s exports in competing products. Cheaper imports into India will further hurt India’s already struggling industries. US and EU exports to China may suffer on lower demand, which, in turn, can impact their demand for other countries’ exports.
While the recent upward trend in commodity prices may be arrested, the rupee may come under downward pressure as the dollar gains strength vis-à-vis the yuan, as in 2015. A sudden rush to safe havens such as gold and the dollar cannot be ruled out. India must take steps to avert disruption as it grapples with its own slowdown concerns.