Australia has just five years to prepare for risks from China debt: Morrison

Australian Financial Review Sep 28 2016 11:45 PM

Laura Tingle

Australia has five years to make its budget more resilient to a potential economic shock from booming debt levels in China, Treasurer Scott Morrison says.

His warnings came after the release of the latest World Economic Outlook from the International Monetary Fund on Wednesday, which said China must allow its economy to slow to stop a "disorderly deleveraging", triggering contagion in emerging markets, and hitting asset prices in advanced economies.

The IMF said China's financial links with the rest of the world were now sufficient for a major shock to affect global stock prices, debt markets and currencies, particularly for Beijing's major trading partners such as Australia.

"Adverse shocks in China reduce equity prices both in advanced and in emerging market economies, with stronger effects on countries with higher trade exposure to China," the IMF said.

 Mr Morrison said that while he did not think China "would welcome lectures from Australia on how to manage burgeoning debt in Chinese state-owned organisations and regional governments it's very important that we keep a watching eye on this".

"There's not a lot Australia can do about this," Mr Morrison told Sky. "These are matters for the Chinese government and I don't think they would welcome lectures from Australia on how they need to manage that."

Repeating warnings he made about a China debt crunch last month, Mr Morrison said it was "important for us to be mindful of those vulnerabilities".

However, he said he believed "it's within the wit and the means of the Chinese government to resolve those issues", saying they had "the resources to do that".

"They are self-funding in terms of their own financial position," he said. "This will be a matter of where the debt sits within the Chinese economy. Whether it sits in the [state-owned enterprises] directly and the local government and administrations or it sits in the central government level.

"At the central government level their debt issues are far less dramatic, the debt issues arise in a lot of those other agencies, particularly in government but also in the private sector in China.

"So we need to be wary of that. But what does that mean for us? It means that we've got five years or so to ensure that we increase our resilience. We need to do that by getting the budget back into balance."

The Treasurer said that was why the government was focused on cutting spending, saying it was good to strike a deal on the $6.3 billion of savings contained in the Omnibus Bill.

 "But that is just the start. We've got another $6 billion  in social services measures, which the Labor Party continues to oppose. So they're not getting on board with that."

 Mr Morrison said "we'll work the crossbench on that. In total, we've got some $40 billion worth of budget improvement measures. We've already got through over a quarter of those, getting that through the Parliament in these few weeks. Within the first 100 days of government, getting stuff done."

At the top of the IMF's list of issues requiring attention was a plea for Beijing to give up on "unsustainably high growth targets" by keeping "credit growth in check".

In March, Premier Li Keqiang surprised many by affirming the Communist Party was committed to doubling the size of the economy between 2010 and 2020.

This will require a growth rate of around 6.5 per cent over the next four years.

To achieve this target China has been pumping credit into the economy at the fastest rate since the 2008 global financial crisis. This has seen credit grow this year at an annual rate of around 13 per cent. The country's debt-to-GDP ratio, meanwhile, has risen to 250 per cent of GDP, which is very high for a developing economy.

The IMF said putting a  brake on credit growth should be done by restructuring weak firms or allowing them to fail, ensuring banks recognised bad debts and by reining in the poorly regulated shadow banking sector.

"A comprehensive plan to address vulnerabilities in the financial sector is needed," the IMF said.

"A disorderly deleveraging … could trigger contagion in emerging market financial markets."

China has been criticised in recent years for not moving quickly enough to clean up its debt-laden state sector to allow more room for innovative private sector firms, which are the main creators of jobs.

But in the last week it has made two major announcements that suggest it is starting to tackle difficult reforms.

Beijing has forced the merger of the Baosteel Group and another state-controlled firm, Wuhan Iron & Steel, in a deal that will create the world's second biggest steel maker.

On Monday it announced a restructuring fund  that could eventually be worth 350 billion yuan ($70 billion) and will be used to fund mergers, debt restructurings and capacity cuts.