People’s Republic of China: Selected Issues

Selected Issues


Selected Issues

Credit Booms—is China Different?1

  • International experience suggests that China’s credit growth is on a dangerous trajectory, with increasing risks of a disruptive adjustment and/or a marked growth slowdown.

  • Average real GDP growth would have been around 5½ percent over the last five years in the absence of excessive credit growth (ceteris paribus). If the government maintains its current growth strategy, the credit-to-GDP ratio would increase by another 60 ppt to more than 290 percent by 2022.

  • Several China-specific factors—high savings, current account surplus, small external debt, and various policy buffers—can help mitigate near-term risks of a disruptive adjustment and buy time to address risks. But, if left unaddressed, these factors will likely not eliminate the eventual adjustment, but only make the boom larger and last longer.

  • Decisive policy action is needed to deflate the credit boom smoothly: (i) deemphasize the high and hard GDP targets to contain excessive credit expansion, and reduce credit demand by the least efficient users to increase credit efficiency; (ii) institute reforms to boost consumption to support growth while credit expansion slows.

A. Introduction

1. Strong growth after the global financial crisis was driven by rapid credit growth. Nominal credit to the nonfinancial sector more than doubled in the last five years, and the total domestic nonfinancial credit-to-GDP ratio increased by 60 ppt to about 230 percent in 2016 (Box 1). As a result, the credit gap—deviation of the credit-to-GDP ratio from its historical trend—is currently about 25 percent of GDP, well above the 10 percent BIS threshold for the maximum counter-cyclical buffer.

B. Why Worry About China’s Credit Boom?

2. Credit efficiency has been deteriorating, pointing to increasing resource misallocation. Credit to certain sectors (industrial), firms (SOEs), and regions (Northeast) is significantly higher than their value added, suggesting that they use credit relatively inefficiently. In 2007–08, new credit of about RMB 6½ trillion was needed to raise nominal GDP by about RMB 5 trillion per year; in 2015–16, it took RMB 20 trillion in new credit.


Credit Intensity

Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A002

3. Sustainable growth—growth that can been achieved without excessive credit expansion—was likely much lower than actual growth over the last five years. For illustrative purposes, we estimate growth under a scenario in which the nonfinancial private sector credit-to-GDP ratio had only increased by 10 ppt, leading to no private sector credit gap in 2016. We use two approaches. The first approach calculates credit and GDP growth paths if credit efficiency had worsened less, in line with slower credit growth. The results indicate that average real GDP growth for 2012–16 would have been 5.3 percent rather than the actual average of 7.3 percent. The second approach (Chen and Ratnovksi, 2017) estimates growth using provincial panel data during 2003–15, assuming a lag in the effect of credit growth on output growth. It finds that 2012–16 average real GDP growth would have been 5.9 percent. However, the growth-subtracting effect of credit restraint could have been partly offset by pro-rebalancing, on-budget fiscal stimulus as well as by the productivity gains from more decisive structural reforms.


Sustainable GDP Growth


Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A002

1/ Kang, Chen, and Law (2017)2/ Chen and Ratnovksi (2017)

4. International experience suggests that China’s current credit trajectory is dangerous with increasing risks of a disruptive adjustment and/or a marked growth slowdown. We identify 43 cases of credit booms in which the credit-to-GDP ratio increased by more than 30 percentage points over a 5-year period. Among these, only 5 cases ended without a major growth slowdown or a financial crisis immediately afterwards. However, considering country-specific factors, these 5 country provide little comfort.2 In addition, all credit booms that began when the ratios were above 100 percent—as in China’s case—ended badly.

5. Complex and primarily short-term funding structures underpinning rapid credit growth are a key vulnerability. Banks’ rapid asset expansion has relied on increasingly complex funding structures, extending beyond deposit funding to interbank markets and wealth management products, and via complex and interlinked networks of entities. Asset managers often finance illiquid long-term investments by rolling over short-term funding or pooling investment funds. Complex funding structures and sizable, opaque off-balance sheet investments suggest that a deleveraging process in the financial sector could be bumpy.

C. Can China-Specific Buffers Prevent Financial Stress?

6. There are several China-specific factors that could be mitigating factors over the near term. A current account surplus and small external debt reduces the possibility for a typical external funding crisis as in many other EMs. A low bank loan-to-deposit ratio could help prevent a domestic funding crisis as well. Despite the rapid increase in gross debt, corporate balance sheets have also benefitted from asset values that have increased more than liabilities. Policy buffers can also mitigate the impact of potential shocks: the government can use its fiscal resources to backstop the system, the PBC can always provide liquidity, and capital controls can contain capital flight

7. However, these mitigating factors/buffers do not eliminate the eventual crisis risk and, if the risk is left unaddressed, would just make the boom larger and longer.

  • Strong external position Persistent current account surpluses and low external debt could help avoid a typical external funding crisis as in many other EMs.

    • However, several countries experienced credit booms that ended badly despite running current account surpluses and/or small external debt, as funding crisis could still occur without foreign funding exposure. If financial institutions are expanding their balance sheets by relying on short-term funding amid ample liquidity, a funding squeeze could trigger a downturn/crisis. The U.S. savings and loan crisis in the 1980s, Japan’s banking crisis in 1997, and the U.S. and U.K. financial crises in 2008 are such examples.

  • High domestic savings and stable domestic deposit base. A low bank loan-to-deposit ratio (narrowly-defined, 72 percent in 2016) could help prevent a domestic funding crisis. Even the total nonfinancial domestic credit-to-GDP ratio at 118 percent is well below other countries that experienced funding crises (e.g., 400+ percent in Korea (1998), 350+ percent in the US (2008), 250 percent in Japan (mid-1990s)).

    • However, loan-to-deposit ratios do not capture total assets and liabilities. Many countries experienced crises despite stable deposit funding; these cases are usually associated with balance sheet expansion through non-loans and non-deposit funding. Many of these assets may be weakly regulated (and collateralized), while funding sources tend to include interbank exposure, which potentially increase systemic risk. In China, the ratio of non-loan assets to total assets is about 50 percent in 2016, higher than the median in the cross-country sample.

  • Strong asset side of balance sheets. Corporate balance sheets have benefitted from rising asset values, which have increased more than liabilities. So, leverage as measured by the debt-to-asset ratio has been falling.

    • However, asset valuations could fall sharply were the boom to end. Corporates’ liabilities are mostly financial liabilities, while a significant portion of assets are nonfinancial fixed assets (e.g. land), which may not be easily liquidated and are subject to sharp valuation changes. In addition, more vulnerable firms—for example, those with lower debt servicing capacity—tend to hold fewer liquid assets, implying that such firms would have lower buffers during times of stress.

  • Ample fiscal space in a state-controlled economy. The government has fiscal space with official general government debt of less than 40 percent of GDP as of 2016. The government could use its resources to backstop the system.

    • However, actual fiscal space is limited and is eroding with “augmented” debt projected to rise to more than 90 percent of GDP over the medium term, with debt on an unsustainable path. The economy-wide cost of bailouts is likely to be larger than just the direct costs for the financial system due to indirect costs (slower GDP growth, lower tax revenue, higher government spending, higher interest payments, and contingent liabilities). The process of bailing out may not be smooth, and even if the government successfully uses fiscal resources, it could deepen moral hazard and increase the potential cost of future bail outs.3

  • Liquidity provision and capital controls. The PBOC can always provide liquidity against funding stress and capital controls are still very effective.

    • However, even quick action by central banks may not be sufficient (e.g. the U.S. in the global financial crisis) given the size, complexity and interconnectedness of the system. If funding stress were to occur (such as in small banks or non-banks), it is uncertain if such stress could be contained by the authorities given the complexity of the system. Liquidity provision could also lead to capital outflows and FX pressure, as well as exacerbating moral hazard. Capital controls could be tightened substantially, but this could spur a growth slowdown and possibly provoke further capital outflows. Further, such controls tend to lose effectiveness over time.

  • Strong growth and financial deepening. Rapid credit growth is natural consequence of strong underlying growth and could reflect financial deepening.

    • However, faster growth is unlikely to be the answer as the efficiency of investment/credit is falling sharply and financial performance (profitability, leverage, debt servicing capacity) of corporates—particularly SOEs—is deteriorating, affecting asset quality of banks. China’s rapid financial deepening has exceeded the turning point that maximizes the positive effect on growth (IMF SDN/15/08); further financial deepening could even drag growth lower.

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8. These factors buy time to address risks from the unsustainable credit growth and allow China to delever gradually. We consider an illustrative proactive scenario under which faster progress on enacting structural reform (especially SOE reform) and improving overall efficiency in resource allocation would allow credit growth to slow gradually, while supporting medium-term growth prospects. Near-term growth could dip reflecting the faster adjustment, but medium-term growth would rise driven by higher TFP growth (Lam and others, 2017). Improved credit efficiency would help raise GDP growth even with slower credit growth over the medium term (private credit growth of about 8½ percent), which would stabilize the ratio of total domestic nonfinancial sector credit-to-GDP at about 270 percent in 2022.

9. Decisive policy action is thus needed to deflate the credit boom smoothly. A precondition is to deemphasize high and hard GDP targets and the attendant excessive credit necessary to achieve these targets. To support growth while credit expansion slows, a comprehensive strategy is needed to increase credit efficiency by reducing demand for least efficient/productive uses. Financial reforms are also necessary to bolster the regulatory and supervisory framework, including closing loopholes for regulatory arbitrage, reining in leverage and increasing transparency of nonbank financial institutions and wealth management products (Box 2).

Measuring Credit: How Large Is China’s Nonfinancial Sector Credit?

  • The narrowest measure is banks’ claim on the private nonfinancial sector, which stood at about 155 percent of GDP as of 2016.

  • Total social financing (TSF) statistics capture not only conventional bank loan channels but also financing through off-balance items of financial institutions—trust loans, entrusted loans, and undiscounted bankers’ acceptances—and corporate bond issuance. As of end-2016, TSF stock was about 209 percent of GDP, of which households accounted for about 44 percent. Separately, official general government debt is about 37 percent of GDP.

  • Total domestic nonfinancial sector credit is estimated to be about 234 percent of GDP, smaller than the sum of above TSF and general government debt. It is largely because former credit to LGFVs which was explicitly recognized as local government debt (about 17 percent of GDP) is captured both in TSF and general government debt statistics.

  • The treatment of LGFV debt that has not been explicitly recognized as government debt straddles the border line between public and private debt. From a legal perspective, the authorities’ definition of general government debt (37 percent of GDP), which includes only former LGFV borrowings that were explicitly recognized as LG debt, is public debt and the remaining is private debt (197 percent). But assuming that the non-recognized LGFV debt resulting from public policy and social capital portion of government guided funds and special construction funds are contingent government liabilities, “augmented” debt is then total public debt (62 percent of GDP as of 2016) and the remaining nonfinancial sector debt is private debt (172 percent).

The IMF’s Institutional View on Monetary Policy and Financial Stability

  • In principle, monetary policy should deviate from its traditional objective of price and output stabilization only if costs are smaller than benefits. Costs of raising interest rates arise in the short term from lower output and inflation. Benefits materialize mainly in the medium term, as financial risks are mitigated, though effects are more uncertain.

  • The case for leaning against the wind to counter financial risks is generally limited. Even if benefits outweigh costs, implementation remains challenging, including detecting vulnerabilities and predicting crises in real time and calibrating monetary with prudential policies.

  • Macroprudential policies should be the key instrument in preventing financial instability. These measures, when well targeted and effective, can target imbalances and market imperfections much closer to their source than monetary policy. Also, they could allow monetary policy to focus on its price stability mandate.

  • However, benefits can plausibly outweigh costs in some circumstances, particularly if the transmission mechanism of interest rates is clear. For example, when credit growth is rapid, rate hikes could have a stronger effect on credit growth and crisis probability by discouraging exuberant, self-fulfilling behavior. Benefits also rise when crises are likely to be particularly severe due to a large and interconnected financial system and the absence of well-targeted macroprudential measures.


  • Bova, Elva, Marta Ruiz-Arranz, Frederik Toscani, and H. Elif Ture, 2016, “The Fiscal Costs of Contingent Liabilities: A New Dataset”, IMF Working Paper 16/14.

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  • Chen, Sophia and Lev Ratnovksi, 2017, “Credit and Fiscal Multipliers in China”, manuscript

  • Dell’Ariccia, Giovanni, Deniz Igan, Luc Laeven, and Hui Tong, 2012, “Policies for Macrofinancial Stability: How to Deal with Credit Booms”, IMF Staff Discussion Note 12/06.

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  • Laeven, Luc and Fabian Valencia, 2010, “Resolution of Banking Crises: The Good, the Bad, and the Ugly”, IMF Working Paper 10/146.

  • Lam, W.R., Y.Y. Tan, Z.B. Tan, and A. Schipke, 2017, “Tackling Corporate Debt and Achieving Productivity Gains—The Central Role of State-owned Enterprises,” forthcoming IMF Working Paper.

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  • Sahay, R., M. Čihák, P. N’Diaye, A. Barajas, R. Bi, D. Ayala, Y. Gao, A. Kyobe, L. Nguyen, C. Saborowski, K. Svirydzenka, and S.R. Yousefi, 2015, “Rethinking Financial Deepening: Stability and Growth in Emerging Markets”, IMF Staff Discussion Note 15/08.

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Prepared by Joong Shik Kang, Sally Chen, and Daniel Law.


The credit boom in New Zealand (1992) was due to a one-off credit expansion in 1988 from a low base. A boom in Hong Kong SAR (1983) should be seen in the context of its role as a global financial center. A boom in Finland (2003) was the result of economic recovery after large deleveraging in late 1990s. Credit booms in Indonesia (1990) and Switzerland (1985) eventually led to crises after futher credit expansion.


In cross-country studies, the average direct fiscal cost has been estimated to be 5–10 percent of GDP (Laeven and Valencia, 2010) and indirect fiscal cost arising from the contingent liabilities realization is estimated to be about 6 percent of GDP during 1990–2014 (Bova, et al., 2016). Dell’Ariccia et al. (2012) also estimate the average gross fiscal cost of systemic banking crises to be about 15 percent of GDP.