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In his address to the Australia-China Relations Institute (ACRI) this week, Mr Lowe cautioned that the build-up of debt and bad loans in China over the last decade is highly risky to Australia because, historically, such circumstances have “almost always” led to a slowdown in GDP growth or a financial crisis.
The governor explained that the increase in China’s debt-to-GDP ratio over the last decade has been larger than all other major economies, growing from approximately 140 per cent in 2008 to 260 per cent in 2017, based on data from the Bank for International Settlements.
“Among the largest economic risks that Australia faces is something going wrong in China,” the RBA governor said, noting that China is Australia’s largest trading partner, accounting for nearly one-third of exports and around one-fifth of imports.
“As the economic relationship between our two countries broadens and deepens, developments in China are having a material impact on more and more Australian industries: it is more than just about resources.”
He added that the risk to Australia is compounded by the “complicated” nature of China’s financial system. Due to centralised controls, businesses have restricted access to credit from state-owned banks, resulting in them sourcing funds from non-bank financial institutions with higher interest rates and riskier terms.
“On the one hand, the influence of the state and the incentives within financial institutions have almost surely distorted credit allocation and led to some poor lending decisions,” Mr Lowe said.
“On the other hand, though, the involvement of the state can make it easier to work through problems when they arise... The state has the capacity, and the demonstrated willingness, to address financial problems when they occur.”
He said that it’s too early to make a call on whether China will be successful in its efforts to transform its economic growth model to one that is less reliant on the build-up of debt. This is because China’s challenge is made particularly difficult by the two seemingly conflicting outcomes that need to be achieved: reduce China’s debt levels and improve access to finance.
“There are pressing needs to make financing more widely available to small and medium enterprises, to strengthen the pension system to bolster retirement incomes, to increase transparency and reduce implicit guarantees associated with local government and SOE borrowing. So, there is still a lot to be done,” Mr Lowe said, adding that the RBA will be closely watching the transition process.
Contrary to outsider scepticism towards China’s willingness to address economic vulnerabilities, Mr Lowe remains “optimistic” about the nation’s ability to reform its financial system, saying that authorities are responding to the risks as a priority before it becomes a financial crisis.
“[The] lower economic growth target for 2018 of 6.5 per cent suggests some tolerance for a gradual slowing in growth. This is a positive development, given that over recent years there was a concern that the authorities would fail to address the financial risks for fear of damaging the economy in the short term,” Mr Lowe said.
The RBA governor concluded his address by reiterating that a “stable and robust financial system in China” is ultimately good for Australia, and that both nations have a role to play in building a “thorough understanding of [each] other”.
Mr Lowe’s address follows political developments indicating the deterioration in Australia’s relationship with China. Earlier this week, China’s state media suggested that the nation could impose trade sanctions on Australia, valued up to US$10 billion.
[Related: Analysis: How risky is our dependence on China?]
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