China’s Shadow Banking System and Its Lurking Credit Crunch: Causes and Policy Options

In June 2013 the Chinese government and thereby the People’s Bank of China (PBC) shocked the world markets by refusing to lend out money any further to Chinese banks, therefore causing turmoil on the Chinese interbank market. This so-called Shanghai interbank offered rate (Shibor) crisis made it clear that the PBC was not willing to provide unlimited liquidity after China’s money supply far outpaced its GDP growth for more than a decade. Although the government has set a new annual GDP target at 7.5 per cent over the period 2011–15, it keeps investing in order to hold the GDP growth, and as a result China’s debt burden is rising — not just the absolute amount of debt in the economy, but also the annual cost of servicing that debt relative to its GDP. After the credit crisis in 2007–08, the aggressive stimulus measures to boost economic activity required the authorities to relax controls on local government spending programs, and since then China’s credit and debt ratio expanded much faster than its GDP growth. Currently China seems to be in a similar predicament to several of the developed economies prior to 2008, since too much credit has been created too quickly and too much money has been poured into investments that are unlikely to generate sufficient cash flows to pay off the debt. China’s stock of credit has soared to more than 200 per cent of GDP, having risen steeply over the past five years.