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China’s debt-to-GDP ratio manageable

Daryl Guppy
Daryl Guppy • 6 min read
China’s debt-to-GDP ratio manageable
(Aug 14): China’s monthly, quarterly and annual growth remains stubbornly persistent. It is as stubbornly persistent as some commentators who continue with talk of rigged figures, manipulated results and suspicious levels of economic activity. Say what
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(Aug 14): China’s monthly, quarterly and annual growth remains stubbornly persistent. It is as stubbornly persistent as some commentators who continue with talk of rigged figures, manipulated results and suspicious levels of economic activity. Say what you will about the quantum of China’s growth, it is undeniable that the growth is remarkably steady.

In a perverse application of economic analysis, what is acceptable or good in Western economies is not so good in the Chinese context. It is a common belief that China’s already-high debt levels are growing too fast and threaten its extraordinary run of economic growth. The proof is said to be in its debt-to-GDP ratio. This is generally estimated to be about 280%.

Taken by itself, this figure seems large. But put into context, it is uncomfortably normal. It is about the same as the British debt-to-GDP ratio. It is only slightly larger than the debt-to- GDP ratio of the US and the European Union. Why is it that these ratios are not a concern in Western economies but are the harbingers of doom in China?

According to many Western observers, China must tackle its debt problem with an urgency that does not apply to Western economies. With a wisdom born of experience, these observers note the central role of debt in the global financial crisis. It is a valid observation, but also one that ignores the current high levels of debt-to-GDP that underpin the Dow Jones Industrial Average’s move past 22,000. In China, these debt-to-GDP levels have many Western observers worrying that the country is heading towards some kind of financial meltdown.

These observations ignore the way China’s regulators have both carefully and successfully managed the Chinese economy and growth since the 2008 global financial crisis. It is difficult to deny that the global impact of the finan cial crisis struck China a glancing blow rather than brought the economy to its knees, as happened in the US and Europe.

Unlike Western countries, the Chinese government largely owns the biggest lenders, the banks. It also owns many of the larger corporate borrowers. This gives the govern ment significant influence over debtors and creditors in the system. The crackdown on borrowing by state-owned enterprises and the slow consolidation among SOEs illustrate both a unique situation and unique solutions.

More importantly, more than 95% of the debt is locally financed, mainly through the banking system. This is not foreign-funded debt that will run away at the first hint of trouble.

This growth and economic management is possible because domestic savings are very high and held mostly as deposits in the banks.

No financial chicanery is required here to manufacture credit, with fancy financial instruments such as new “safe synthetic” versions of the collateralised debt obligations that were instrumental in triggering the global financial crisis. Now, they are called a bespoke tranche opportunity. This is essentially a CDO backed by single-name credit-default swaps and customised based on investors’ wishes.

Chinese policymakers are intent on lowering the pace of credit. They are moving decisively to reduce risks in the so-called “shadow banking” sector at a time when this area is again growing in Western economies.

We can approach China is many ways, but it is unwise to continue to attempt to write off its ability to continue with steady economic growth. The consolidation in the trading band between 3,265 and 3,290 has been volatile. This has included a dip down to the value of the upper edge of the long-term group of moving averages in the Guppy Multiple Moving Averages indicator. This was followed by a fast rebound and a close above the lower edge of the short-term GMMA.

This is not the end of the uptrend, but it shows that the uptrend momentum is slowing. The triple-top pattern resistance level near 3,290 is very strong. The short-term GMMA is compressing, but it has yet to cross and turn downwards. This compression may be part of the consolidation pattern that forms a base for a new rally test of the upper edge of the consolidation area. It is too soon to know how this will develop.

On July 18, the Shanghai Index dipped and tested the value of the long-term GMMA. Investors are watching carefully to see if the current dip is a repeat of the behaviour seen on July 18. Here are the key signals for a trend continuation, or a trend change. For a trend continuation, investors watch for the index to rally and retest the upper edge of the trading band near 3,290. A sustained breakout above 3,290 signals a continuation of the uptrend.

The key signals for a change in the trend are more complicated. They include:

  • Compression in the long-term group of moving averages. This shows investors are losing confidence in the strength of the uptrend;
  • Crossover in the short-term GMMA as this group of averages turns down and moves into the long-term group of moving averages. This shows traders have lost confidence in the continuation of the uptrend; and
  • A sustained fall below the lower edge of the long-term GMMA near 3210.

Normally, it takes some time for these signals to develop. The Shanghai Index is showing consolidation behaviour between 3,265 and 3,290. The current behaviour is more volatile, with some rapid intraday dips below 3,265. This behaviour is critical because it defines the area that has the potential to become a triple top pattern.

There is a danger that the double top will become a triple-top pattern with the market failing to move above 3,290. In this situation, the market may develop some consolidation between 3,265 and 3,290 before retreating and retesting the lower area near 3,130.

It is too early to know if this breakout will develop, or if it will fail and become part of a triple-top pattern. The key feature investors are watching is the behaviour of the index consolidation between 3,265 and 3,290.
Daryl Guppy is an international financial technical analysis expert and special consultant to AxiCorp. He has provided weekly Shanghai Index analysis for mainland Chinese media for more than a decade. Guppy appears regularly on CNBC Asia and is known as ‘The Chart Man’. He is a national board member of the Australia China Business Council.

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