China’s misunderstood debt challenges

China’s heavy debt burden continues to worry investors. We think that China’s strong external balance sheet, heavily managed capital account and healthy trade balances reduce the likelihood of a financial meltdown. That said, we envisage a sustained period of slow growth and continued rebalancing in the economic composition of the world’s second largest economy.

The exponential growth of debt across key sectors of the Chinese economy, especially since 2008/09 continues to be a source of deep concern for investors.

Indeed, the heavy debt burden makes China vulnerable to financial and economic shocks. Given China’s important role in the world’s economy, such a scenario carries serious negative consequences for the rest of the world.

It would be wrong to underestimate the challenges China faces as it tries to sustain growth, rebalance its economy and manage its debt load. But we believe there are important backstops in place, which make the likelihood of a sharp financial meltdown very unlikely over the next two to three years. Moreover, it is important to note that China runs a relatively closed capital account with powerful controls, further mitigating the risks of broad-based domestic capital flight.

Lastly, as the rebalancing in China’s growth model takes place, some specific opportunities are being created, notably in China’s emerging e-commerce and travel sectors. In the absence of a worst case financial meltdown scenario, these look attractive.

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