5 reasons China may be on verge of financial meltdown

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5 reasons China may be on verge of financial meltdown

The economic instability in China is no longer a domestic matter with the Shanghai Stock index losing 20% of its value since January 2016. The meltdown driven by sluggish exports and the government’s desperate measures to correct the much anticipated downturn is a clear indicator that Chinese economy is in turmoil. As a consequence, it is affecting the global financial markets.
Here are the 5 key reasons, why China maybe on the verge of a financial meltdown:

 

#1. Slipping Yuan

 

China has been deploying its foreign reserves to support the yuan, which is pegged to a basket of foreign currencies including the U.S. dollar. According to Trading Economics, China’s foreign reserves fell by $87 billion in November 2015 to $3.43 trillion, the lowest in almost three years. It is evident that China does not want to let the yuan slip anymore, which is causing them problems domestically.

 

#2. Global Consumption Slowdown

 

The global consumption worldwide has massively affected China in a great deal which follows an export led model of the economy. China is a leading exporter in steel and cement.  Most of these raw materials are used in manufacturing and China exports and also consumes these a lot. The sudden slowdown in the economies all over the world has adversely affected China. This has made the manufacturing sector of China bleeding. Thus, the Chinese government has been controlling its currency to make the exports more viable and to bring the economy on the right track.
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#3. Credit Trap
Problem loans have doubled in two years and officially, are already 5.5% of banks’ total lending. The reality is grim. Roughly two-fifths of new debt is swallowed by interest on existing loans. In 2014, 16% of the 1,000 biggest Chinese firms owed more in interest than they earned before tax. China requires more and more credit but it is generating less and less growth: it now takes nearly four yuan of new borrowing to generate one yuan of additional GDP, up from just over one yuan of credit before the financial crisis. With the government’s connivance, debt levels can probably keep climbing for a while, perhaps even for a few more years.  China is the world’s second-biggest economy; its banking sector is the biggest, with assets equivalent to 40% of global GDP. Its stock markets, even after last year’s crash, are together worth $6 trillion, second only to America’s.

 

#4. Fiscal debt

 

It doesn’t take an advanced degree in mathematics to figure out that if budget commitments are growing at double digit rates while the economy is growing at single-digit rates, something has to give. That something is the fiscal deficit. China is going into debt – in a serious way. China is nowhere near the fiscal sophistication of the US. China’s tax revenues are rigidly tied to economic growth: It relies heavily on inflexible taxes that grow at the same rate as the economy as a whole. That was fine when the economy was growing at 10 percent every year. Now it may be more of a problem.

 

#5. Banking System

 

The rise of Chinese shadow banking, beginning around 2010, focused on banks shifting loans off-balance sheet through partnerships with non-banking financial institutions such as trust companies and securities brokerages. During the past two years, however, midsized banks have rapidly expanded on-balance sheet assets. Aggressive balance sheet expansion by midsized lenders has also increased their systemic importance to China’s overall banking system. The big four’s share of total banking assets has fallen from 51 per cent in 2009 to 38 per cent at the end of 2015.

 

Thus, we see that there are a number of reasons why Chinese financial system might collapse. But given various situations globally, such as the recent Brexit vote, upcoming American elections and the change of RBI governor in India, only time will tell if Chinese financial system collapses or if it finds a way out and moves towards stabilization !