Singapore wealth fund Temasek: How a financial crisis in China might play out

Key Points
  • Michael Buchanan, head of strategy at Singapore wealth fund Temasek, said on Thursday that concerns over China's debt were focusing on the wrong scenario.
  • Buchanan noted that China may not be over-investing, while infrastructure plans may help address overcapacity.
Vivek Prakash | Reuters

Doomsday predictions for China's economy have a long history, but most are looking at the wrong scenario, Michael Buchanan, head of strategy at Singapore wealth fund Temasek, said on Thursday.

"If you're using the metrics from the Asia crisis, you're going to get the wrong answer," Buchanan said at the DBS Institutional Investor Symposium in Singapore.

"No one was saying to Thailand back in 1996, when it was running a 7.7-7.8 percent current account deficit, massively overvalued currency and no reserves, you need to consume more," he said.

In the late 1990s, Thailand was "Ground Zero" for the Asian Financial Crisis after a surfeit of dollar-denominated debt combined with a forced devaluation of the baht, when it was allowed to float freely. That spurred contagion first around the region and later to other emerging markets globally.

But China has set on a course of boosting domestic consumption, while pivoting away from manufacturing- and investment-led growth. The service sector, which includes consumer industries such as real estate, retail and leisure, has overtaken manufacturing to become the majority of the mainland economy.

But concerns have persisted over the mainland economy's health, as private-sector debt has surged even as the amount of growth from additional debt has declined.

But Buchanan pointed to where in the economy the debt was pooling.

"It's not the households. It's not the government, at least at the starting point, that has a lot of the debt. It's the corporate sector," he said. "So you look at the corporate sector and look at the interest bill versus earnings and if that gets too scary, then you're going to have concerns over the banks, and then you get deposit flight and then the government has to make some serious choices about currency stability versus tighter domestic liquidity."

But he added, that while that was the framework of a potential crisis in China, it was a long way off.

Indeed, Buchanan questioned the basis for concerns that China was over-investing.

"When people talk about investment, no one bothers to distinguish flow and stock," he said.

Stock generally refers to an existing quantity at a specific moment in time, such as the total value of assets, while flow would be measured over a period of time, such as gross domestic product for a full year.

While China's flow rate for investment was unprecedented, as a "stock," it was a bit more than 10 percent of the U.S. per capita levels, he said.

"The capital stock has not necessarily been overbuilt," he said, adding that there was an inconsistency in complaining about whether China's investments were efficient, while urging it to increase consumption.

"The efficiency of investment of investment might not be great, but there's no return on consumption," he said. "It's a little bit inconsistent to say, 'Gee you built the schools in a really inefficient way. I wish you'd bought donuts,' which is what a lot of people have been saying about China."

Buchanan also noted that China was taking steps to address overcapacity in its economy, pointing in particular to the mainland's One Belt One Road initiative, which was launched in 2013 by President Xi Jinping to revive the ancient Silk Road and create ties across at least 60 countries with improved infrastructure.

Buchanan wasn't alone in questioning whether concerns about China's investment levels were misplaced.

Elena Okorochenko, head of Asia Pacific ex-Japan at S&P Global Ratings, noted at the symposium on Thursday that China would need to make significant investments in electricity production as around two-thirds was currently using coal and the country was pushing for greener practices.

That's not to say that concerns over China's use of debt could be shrugged off.

Last month, Moody's Investors Service expressed concern that China's effort to support economic growth would spur higher debt levels, and the ratings service downgraded the mainland's credit rating to A1 from Aa3, changing its outlook to stable from negative.

Moody's estimated that while the government budget deficit in 2016 was "moderate" at around 3 percent of gross domestic product (GDP), it expected the government's debt burden would rise toward 40 percent of GDP by 2018 and 45 percent by the end of the decade.

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