Chinese economy which has been growing rapidly in the last two decades is in for a major shift. Chinese economy which grew 10 percent in 2012 has slowed down to a growth rate of 7 percent in 2013. This is still high but not quite as high. First, their exports which was around 8.3% of 2007 GDP has crashed to 2.6 percent of 2011 GDP. However during the same period the rate of investment rose from 42 percent to 48 percent.
What then seems to be the problem? Chinese investment which has been soaring over the years has come to a halt as the expected returns from these investment has been falling steadily. The growth was achieved primarily from borrowing and this is not happening now. A study made by the IMF shows that China has been over investing by 12 to 20 percent of GDP.
The rate of growth of credit in China has been at an astonishing level compared to their GDP growth. The question now is not whether the credit growth will stop but how and when the accumulation of debt is likely to end as growth peters out. The longer the credit growth goes on the greater the risk of a nasty surprise down the road.
How did this credit grow? According to the IMF low interest for household savers helped subsidize investment to the tune of 4 percent of GDP of a year. Because of the growth there has been an explosion in credit and debt. Social financing as the Chinese call it has reached 200 percent of GDP up from 125 percent in the 2007.
Finally, the present explosion of credit growth has left the Chinese government with an apparent dilemma either to let the debt accumulation continue creating bigger problems in the future or implement rapid reform and risk a fall in investment and a bigger unplanned slow down. We will wait and watch.