Mapping out contingency plansA nightmare may be in the making. Financial markets across the world have been rattled by the U.S. government’s plan to wind down five years of heavy monetary stimulus. Adding to that scare, China showed clear signs of a slowdown in its economy, which has helped fuel the global economy. U.S. Federal Reserve Chairman Ben S. Bernanke announced that the central bank will gradually scale back its multibillion-dollar bond-purchase program and possibly terminate quantitative easing entirely next year. Stock prices around the world tumbled and interest rates shot up.
The latest manufacturing survey from China underscored that the industrial powerhouse was losing steam and raised deep concerns about the world’s second largest economy. Interbank lending rates shot to record highs in China and the government did nothing to intervene, a signal that it wants excess lending curbed. Experts are downgrading economic forecasts for China. Moreover, alarms have been raised about the country’s financial sector amid concerns about defaults by local governments struggling to pay off debt they borrowed for modernization and construction projects, which helped fuel the country’s staggering economic growth.
Debt by local governments and agencies ballooned over the years amid a lending boom led by state-run financial institutions to maintain the country’s impressive growth levels after the U.S. financial meltdown in 2008. Some foreign investment banks put their debt levels at about the half the size of the country’s gross domestic product. Large state-run agencies began to go bankrupt, raising fears about a liquidity crisis in China’s non-banking sector.
The scare spread quickly on the markets. Short-term interest rates surged to record-high levels. The seven-day inter-bank rate - interest rates Chinese banks must pay to borrow money from each other - shot up to 28 percent to close Friday at 10.8 percent - compared with a 2.7 percent average since 2006. The Chinese central bank had to issue a statement denying concerns about liquidity crisis.
Beijing authorities won’t likely let the financial sector face a liquidity crunch. But an economic slowdown will surely hurt our economy given that China is our biggest trade partner. Our economy may not even be able to maintain growth in the 2 percent range if exports fall further due to reduced demand in China. The government must be vigilant and map out contingency plans for the economy against such growing risks.