Leveraging up again

Nominal GDP growth and credit growth almost converged at the end of 2018, but the gap between them has widened again this year as growth has slowed and policymakers have shifted their focus away from deleveraging and towards supporting growth. (See Chart 1.) As a result, China’s debt ratio has started to creep higher again after stabilising last year. If we are right that growth will slow further over the coming quarters despite additional policy easing, the gap between nominal GDP and credit growth is likely to widen further, which will push up the debt ratio even more. A rising debt ratio naturally raises concerns about financial risks. But even if these can be mitigated, a more fundamental reason for concern is that the rising ratio reflects poor allocation of credit (and other resources). Unless broader reforms are implemented this will weigh significantly on growth.