Deleveraging a tricky task

Government must act prudently as any wrong move in this process could cause risks to converge in its financial system

China's economy is now changing gear from its previously fast-paced growth to a moderately lower speed, during which the government has to continue to push forward economic structural adjustments and address the side effects of the large-scale economic stimulus package it adopted in the wake of the global financial crisis in 2008.

However, the country not only faces the pressures of a decelerating economy, the government also has to be on the alert around the clock ready to address the looming risks emanating from colossal local government debts, shadow banking, industrial overcapacity, as well as the possible busting of its real estate bubble.

Plagued by increased pressures from the economic downturn and its economic imbalances and vulnerability, the government urgently needs to address these issues, but must take care when doing so that it does not trigger a financial crisis.

The huge balance sheet pressures on the country's financial, real economy and public sector mean the past high debt leverage model is unsustainable and thus deleveraging remains an irreversible trend. Given that any deviation or wrong moves in this process will possibly cause various risks to converge in its financial system, the government should make effectively preventing the risks from triggering a systemic financial crisis a top priority.

But for an economy that has experienced extensive growth for decades, deleveraging will not be a quick or easy task.

Prior to its subprime mortgage crisis, the United States also experienced a rapid credit expansion over a long period, with its debt growing faster than its nominal gross domestic product. On the eve of the subprime crisis, the size of the US debt had already risen to about 370 percent of its GDP. But owing to the dollar's hegemonic status in the global monetary system, the US' monetary authorities act not only as the major funds supplier but also as the major funds recipient through government bonds issuance and purchase.

Compared with the US, China's macroeconomic conditions are more complicated. On the one hand, the loose monetary and expansionist fiscal policy the government employed to stabilize the country's economic growth in the aftermath of the global financial crisis have accumulated ever-growing government debt. On the other hand, the country's debt risks are mainly concentrated among banks and its financial system, given that indirect financing dominates its financing market.