“Minsky Moment” and financial fragility : The case of China

Abstract

The high GDP growth rate in China has been falling considerably since 2011 and has never got back to the previous amazing double digit number thereafter. Being accompanied by a series of worrisome signs, including booming housing prices and increasing local government debt risk, this situation leads to some pessimistic views concerning the approaching of China’s “Minsky Moment”. However, disagreeing voices exist as well. This paper attempts to assess this controversy from applying Minsky theory. We argue that the heavy debt of local governments may be the main cause for provoking financial fragilities and dragging China into the “Minsky Moment”. We also examine the reasons, size and structure of local governments’ debt, and offer policy recommendations. While Minsky himself and his followers often focus on merely the microeconomic units of banks or firms, we extend the analysis to all the economic sectors including households, firms, foreign sectors, financial institute and government. Both Minsky’s original threefold and Vercelli (2011)’s sixfold taxonomies are applied with empirical data collected from China’s official sources. The calculated results of liquidity ratio and solvency ratio for each economic sector demonstrate that financial institute can be seen as speculative borrowers, while both households and central government are hedge borrowers. However, local governments are in heavy debt. Theoretically, this situation would provoke financial fragility in China, for example, via increasing the non-performing loans. Data analysis indicates that China was not immune to the global financial crisis though it has been less affected from the worldwide recession. In other words, it was nearly in a “Minsky Moment”, while the timely policy adjustment rescued the economy from collapse. Although local government debt situation is now under control and the policy adjustment is on the right track when several local governments are allowed to issue their own bonds, the Chinese economy may still face a risk of approaching the “Minsky Moment”. Additionally, the problems provoked by this trail policy are asking for an urgent need for a fiscal system reform. We thus suggest that more attention should be paid to improving and reforming Chinese fiscal system, particularly to the reforms of the fiscal relationship between central and local governments, the legal framework for local government debt management, expansion of channels for local revenues and readjustments of the tax system.