China is at mounting risk of a financial crisis this year as growth sputters and deflationary pressures trigger a wave of defaults, Bank of America has warned.
The US lender told clients that a confluence of forces are coming together that threaten to chill the speculative mania on the Shanghai stock exchange and to expose the underlying fragility of China’s $26 trillion edifice of debt.
“A credit crunch is highly probable,” said the bank in a report entitled “Deflation, Devaluation, and Default”, written by David Cui and Tracy Tian.
They said the country’s highly-leveraged companies cannot safely withstand President Xi Jinping’s drive to stamp out moral hazard and wean the country off excess credit, warning that the mix of slower growth and excess debt “could prove lethal for the financial system”.
The report warned that it is rare for countries to escape either a financial crisis, or major bank failures, a currency upset, a sovereign crisis – or a mix of these – after letting credit grow at such vertiginous rates.
“The most likely scenario is a bad debt surge as growth slows, followed by a credit crunch in the shadow banking system, followed by a major recapitalisation of the banks,” said Mr Cui.
The report said China spent 15pc of GDP to rescue lenders in the late 1990s but the scale of the problem is much greater today, and this time the government cannot resort to fresh stimulus so easily.
Loans have jumped by roughly 100pc of GDP in the past five years under most estimates. This is twice the pace of growth in Japan over a comparable period before the Nikkei bubble burst in 1990, or in the US before the Lehman crisis in 2008.