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China’s Debt Diplomacy Takes A Credit Hit

SRI LANKA AND Pakistan might count as among the ‘dangerous and chaotic places’ that President Xi Jinping last November advised Belt and Road (BRI) investors to avoid. Both are strategically important waystations along the BRI that are under severe financial stress and in political turmoil.

As friends of China, both would be looking east for assistance, aid that Beijing is being slow to provide. It has not yet reissued a promised $4 billion of loans to replace those Pakistan paid off in late March. Nor has it responded to Sri Lanka’s request for $2.5 billion in credit support.

China has become the largest government creditor over the past decade. Its state-owned policy banks often best the International Monetary Fund (IMF) and the World Bank in annual lending to developing countries.

The scale of that lending and the lack of transparency as to its terms have drawn criticism for exacerbating debt problems in poorer countries and accusations of ‘debt-trap diplomacy’.

Sri Lanka and Pakistan’s optimism that Beijing will come through for them is running into a new realism in Beijing. This is already evident in China’s circumspect approach to debt relief in Africa.

At last November’s high-level BRI symposium, Xi urged a cautious approach to lending along the Belt and Road. For the past couple of years, it has been apparent to top leadership that China’s banks have taken on too much debt in countries with uncertain repayment prospects.

A slowing economy at home and the persistence of domestic financial stability concerns have only made these worries more acute.

Securing approval for new credit lines is becoming harder even for policy banks as authorities emphasise the need for improved risk management and controls.

Sri Lanka has already turned to IMF in Washington for help with preparing an economic recovery programme as a basis for restructuring its debt and emergency financial assistance. Pakistan’s new leaders also plan to work with the IMF to stabilise the country’s economy.

Sri Lanka, in particular, will have as weak a negotiating hand with the IMF as it has had with Beijing.

China’s concern will be that Sri Lanka will have to accede to IMF demands, including who should occupy key government positions. That could mean a government less well disposed to China than some of its predecessors.

Similarly, the ousting of Imran Khan as Pakistan’s prime minister may cost Beijing a friendly if not necessarily firm ally in a country that provides an essential connection between the BRI’s two halves.

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Beijing Remains Cautious Over Debt Relief For Africa

Screenshot of Forum on China and Africa Cooperation (FOCAC) web site, accessed November 30, 2021

THE EIGHTH TRIENNIAL Forum on China and Africa Cooperation (FOCAC) was held today and yesterday in Dakar, Senegal.

President Xi Jinping kicked it off on Monday via video backing up the obligatory mention of a ‘shared future in the new era’ by announcing a donation of 600 million vaccine doses to the continent and promised to make 400 million more available for purchase. 

The less-feel-good items on the agenda include better balancing the continent’s trade with its largest trade partner by increasing the share of African manufactured goods bought by China. 

African manufacturing capacity is a significant constraint. Although Africa accounts for only 4% of China’s imports of manufactures, that is 70% of African manufactured products (2019 data). 

Thus, Beijing promises to increase its investment, particularly in manufacturing, to facilitate the continent’s industrialisation. It also will increase tariff exemptions for some $300 million worth of imported African goods, extend $10 billion in credit facilities to African financial institutions, and promote RMB-denominated trade. 

Yet that is all small beer by the scale of these things, as is Xi’s offer on debt. He did not offer debt forgiveness, only to write off the interest due on some of the loans to Africa’s poorest countries which fall due at the end of this year. It was not clear if that was the African part of the $1.9 billion in payments due this year to China that it has agreed to suspend under the G20’s debt service suspension initiative for loans to the world’s 73 poorest countries, or the $11.5 billion due this year not covered by the G20 programme, of which Angola, Kenya and Ghana own almost half.

Africa is already heavily indebted to Chinese lenders due to Beijing’s drive to secure commodities, farmland and infrastructure construction contracts. China has become the largest bilateral lender to the continent over the past two decades, racking up a tab of some $150 billion to governments and state-owned companies. 

One of every five dollars borrowed by African governments is owed to a Chinese lender. The Covid-19 pandemic is raising questions in Beijing about Africa’s capacity to repay, and even stay current on the interest payments on that debt.

This debt dilemma is the flip side of the commercial diplomacy that has advanced China’s national interests in Africa. Beijing’s past willingness to lend without conditionality and stay out of domestic politics has let it charge high interest rates with low transparency. 

Getting its money back and the damaging reputational risks of high debt and incomplete infrastructure projects may lead Beijing to offer less onerous terms for its latest aid and investment. 

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China’s Debt Diplomacy Dilemma Will Extend Beyond Africa

CHINA’S DRIVE TO secure from Africa commodities, farmland and infrastructure construction contracts has made it the largest bilateral lender to the continent over the past two decades, racking up a tab of some $150 billion to governments and state-owned companies. One of every five dollars borrowed by African governments is owed to a Chinese lender.

The Covid-19 pandemic is raising questions about African capacity to repay, or even to keep current on the interest payments on that debt.

The continent is facing its greatest contraction in GDP in the post-colonial era. That will increase debt service as a percentage of government spending when countries will need funds to stabilise their economies.

On November 13, Zambia, where Chinese firms have copper mining interests and some previous, is likely to become Africa’s first sovereign default in a decade. China has at least as much debt there as the $3 billion owed to the eurobond holders who saw a coupon repayment skipped earlier this month.

There are eight African countries that each owe Chinese lenders at least $5 billion, and barely one that does not owe something. Beijing’s deep pockets and willingness in contrast to multilateral lenders not to become involved in domestic politics, have won it ready borrowers across the continent. However, the price of non-conditionality has tended to be high interest rates and low transparency.

Debt-service relief and fiscal support from multilateral organisations and G20 donors will offer some limited breathing room to African debtors. It may not be sufficient to prevent a liquidity crisis from developing into a debt crisis. However, Beijing has proved reluctant to go along wholeheartedly with the debt relief plans of other international lenders.

The G20 has extended its debt service suspension initiative for loans by its members to the world’s 73 poorest countries to June 2021 with the repayments spread over six years. China is the biggest contributor to the initiative, suspending $1.9 billion in repayments due this year, according to an internal G20 document seen by the Financial Times. That accounts for more than one-third of the total suspended debt service.

However, China is due to receive a further $11.5 billion this year from loans to countries covered by the initiative, with more than $3 billion due from Angola and nearly $1 billion from each of Ghana and Kenya. It is unclear how Beijing will handle that.

The Angola number does not include a further $6.7 billion of debt service payments due this year to China Development Bank, China Export-Import Bank and ICBC that are reportedly being renegotiated directly with the lenders.

This points to a separate track that Beijing is pursing — a debt relief plan of its own. One aspect of that emerged in June when President Xi Jinping announced the cancellation of interest-free debt due to mature by the end of this year for some of the countries that participate in the Forum on China-Africa Co-operation.

A further risk for Beijing is that rising interest rates could make dollar- and euro-denominated debt prohibitively expensive for African countries, pushing them to turn even more to Beijing for help in refinancing their maturing debt. That could test both China’s capacity and, more so, willingness to lend when the quality of Chinese banks’ loan books is of growing concern to authorities at home.

This debt dilemma is the flip side of the commercial diplomacy that has advanced China’s national interests in Africa. However, for Beijing, the predicament is not limited to Africa, which contains only half of the world’s poorest countries. World Bank figures show China’s share of bilateral debt owed by the world’s poorest countries to G20 members rose to 63% last year, up from 45% in 2015.

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Beijing Bolsters Its Banks

THE STIMULUS APPLIED to restore the economy post-pandemic has done nothing to lessen the fragility of an overleveraged financial system. If anything, Covid-19 has slowed the drive to reduce the debt overhang in the banking system.

Authorities have now issued long-awaited draft rules to ensure the capital adequacy of its global systemically important banks (G-SIBs, or those ‘too big to fail’).

The regulations from The People’s Bank of China and the China Banking and Insurance Regulatory Commission (CBIRC) stipulate that from the start of 2025, G-SIBs must be able to absorb losses of at least 16% of their risk-weighted assets, or at least 6% of their total exposures. From 2028, those ratios increase to at least 18% and 6.75%, respectively.

The four biggest state-owned commercial banks are listed as G-SIBS by the Financial Stability Board (FSB), the G20 body set up after the 2008 global financial crisis to monitor the global financial system. They are Bank of China; Industrial and Commercial Bank of China, Agricultural Bank of China and China Construction Bank.

The credit rating agency S&P said last month that the quartet fell short of the capital requirement by 2.25 trillion yuan ($330 billion) as of the end of 2019 and that without raising further capital would be around 6 trillion yuan adrift by 2024. The draft rules will be out for public comment until October 30.

Several regional banks have required bailouts, including Bank of Jinzhou, Hengfeng Bank and most notably Baoshang Bank, which has been allowed to fail, the first Chinese bank to do so in decades.

A national plan was drawn up in May to speed up capital replenishment across the banking system and to put in place the necessary bulwarks against a potential systemic banking collapse by giving central government more coordinating power over provincial-level and below supervision of such actions. Local governments will bear the brunt of the financial burden of recapitalising the banking sector as they own or control either directly or through local SOEs and investment holding companies hundreds of the weakest lenders.

Earlier this year, CBIRC’s vice chairman, Zhou Liang, said that 4,000 of the country’s 4,600 licensed banking institutions were small and midsize banks that together accounted for about a quarter of the sector’s total assets. More than 600 of them are undercapitalised, and more than 500 characterised as of ‘high risk”. That is mainly the result of a combination of lax oversight, poor or policy-driven lending decisions and corruption.

Forced provincial-level mergers of weaker banks are likely, along lines already seen in Shanxi and Sichuan.

Assuming any local political obstacles to restructuring can be removed, there will remain the need to inject better corporate governance, lending standards, risk management and accountability into banks. Whether local authorities have the capacity and expertise, let alone the financial wherewithal to do that is another question. On the last, Beijing is allowing local governments to use 5% of this year’s 3.75 trillion yuan quota of special-purpose bonds for bank recapitalisation.

However, that also raises questions of how far public funds should be used for bank bailouts, as that potentially shuffles where the risk lies rather than reduces it. The same argument can be made about suggestions that the sovereign wealth funds’ investment arm, Central Huijin Investment, should take stakes in financial institutions in need of repair, as it has already done in the recapitalisation of Hengfeng Bank.

The bigger bullet to bite is whether more insolvent banks should be allowed to go bust, although the stalled bankruptcy law for financial institutions needs to become law first.

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China’s Debt Hits Close To Home

THIS BYSTANDER HAS been far from alone in highlighting the tightrope that China’s policymakers have to walk between stimulating growth and accumulating more debt as they manage the structural slow down of an economy switching from industrial to services-led growth and facing adverse demographic changes.

Thanks in  part to the People’s Bank of China (PBOC)’s counsel of restraint, driven by the central bank’s twin concerns of the debt bubble bursting and inflation getting out of hand and its measured but steadfast drive for financial sector liberalisation, Beijing has been selective in its stimulus measures to keep a slowing economy expanding at a sufficient pace to hit the official 6% GDP growth target for this year and the larger one of doubling total and per capita GDP between 2010 and 2020.

While the plan has always been to manage a slowing of the economy as it rebalances towards a more sustainable long-term growth model, the impact of the trade and technology disputes with the United States on world trade have put at risk the 5.5-6.0% growth China needs to achieve in 2020 to hit the overarching decade-long goal.

Earlier this month, the central bank cut its lending rates for the first time in three years. The cuts were a token five basis points for the five-year, one-year and seven-day loan rates. There remains plenty of headroom for further monetary stimulus, but not the appetite, on the central bank’s part at least, to occupy it.

Taking a barb at the United States, PBOC Governor Yi Gang said in September that “unlike central banks of some other countries, we are in no hurry to resort to a considerable interest rate reduction or QE policy”. Yi is keeping his powder dry, in the event that significant rate cuts do become necessary to provide monetary stimulus. Yet his priority is to deleverage the economy, or at least in current circumstances to maintain a “stable leverage ratio…to ensure the debt sustainability of the entire society”, as he put it at the same press conference.

In its latest annual financial stability report released this week, the PBOC gave a stark warning about the potential systemic risk in the buildup of household debt, whose total now equals total household income. One figure that caught this Bystander’s eye was the central bank saying that household leverage had hit 60.4% of GDP at the end of 2018. The Bank for International Settlements had pegged the ratio at 54% (four percentage points higher than in the EU, by way of comparison).

The PBOC is particularly concerned about the growth of mortgages and consumer loans. It has warned previously of the buildup of corporate and local-government debt, but turning its spotlight on household debt is a notable change of focus. Easing of mortgage lending standards to boost property investment and the use of consumer credit to increase retail sales have been the main stimuli of growth in recent years. Rising household incomes make the rise in consumer loans manageable for now, although further buildups would test that assumption, especially among low-income households.

A new IMF working paper on China’s household debt notes that

High household indebtedness could constrain future consumption growth and increase financial stability risks…we find that low-income households are most vulnerable to adverse income shocks which could lead to significant defaults. Containing these risks would call for a strengthening of systemic risk assessment and macroprudential policies of the household sector. Other policies include improving the credit registry system and establishing a well-functioning personal insolvency framework.

Regardless, further consumer-focused fiscal stimulus is likely, perhaps a second income tax to follow last year’s 420 billion yuan ($59 billion) one, and the reintroduction of subsidies for electric and hybrid vehicles.

It is the rise in mortgage loans that more concerns PBOC policymakers. Mortgages account for more than half of all consumer debt. There is evidence that they are inflating a speculative bubble, as well a making affordable housing a politically sensitive issue. Nearly two-thirds of outstanding mortgage debt is accounted for by families owning at least two properties. Some of last year’s tax cut has gone into savings rather than retail consumption, with the saving being in the form of property investment.

This all comes against the background of the crackdown on shadow banking, which included unlicensed digital-payments businesses, online lending and other internet finance companies, in the process shutting down all cryptocurrency trading platforms and more than two-thirds of online peer-to-peer lending platforms.

This has split over into the formal banking sector. Three regional banks, Baoshang Bank, Hengfeng Bank and the Bank of Jinzhou, have needed bailouts this year. Up to 30 more have been late in filing financial accounts required by regulators, suggesting further bailouts to come. In addition, corporate bond defaults this year will likely exceed last year’s record.

The ‘big-four’ state-banks are financially robust enough that any such losses can be absorbed without systemic risk. However, having spent several years engineering higher bank asset quality and lending standards, the PBOC will not want to put the big banks in the position of having to underwrite other institutions’ bad debts. Yi has been clear that any can carrying at a troubled financial institution should be done by its shareholders, not the state via the big-four banks.

Part of the exercise in risk management will require financial-markets reform and further opening to foreign investors. China has moved steadily but cautiously on that. The addition of Chinese stocks to MSCI’s benchmark indices and the likelihood that other index providers will follow suit, adds new urgency.

The changes will bring an inflow of foreign capital into Chinese equities of at least $40 billion this year and, on best guesses, a further $30 billion in 2020. That will provide a welcome influx of capital, particularly for companies in the private sector. It will also offer some relief for a central government whose consolidated deficit, the IMF forecasts, will grow to 6.1% of GDP this year and next, from 4.8% of GDP in 2018. As the late US banker Walter Wriston famously said, “capital will go where it is wanted, and stay where it is well-treated.”

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China Edges Away From Deleveraging And More Towards Stimulus

 

Workers polish escalator parts in Zhejiang,China in 2016. Photo credit: ILO. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivs 3.0 IGO License.

THE DISMAL MONTHLY industrial output numbers for May, the weakest year-on-year growth in 17 years, point only too clearly to the binary choice for China’s policymakers: stimulate to keep the economy on track to grow at the 6% annual rate the official target demands, or deleverage to reduce systemic financial risk and continue to rebalance the economy in the cause of long-term sustainable growth.

They are doubling down on the first. Targeted stimulus, undertaken since last year, has come up short in the face of the global slowdown of growth and trade caused by the uncertainty generated by the United State’s foreign policy in general and trade policy in particular, with China directly in the Trump administration’s crosshairs when it comes to the latter.

Fiscal and now increasingly monetary loosening is already underway and local authorities’ are being given renewed licence to take on debt to enable real estate and infrastructure projects, just the sort of investment that ran up public sector debt in the first place, and which has been steadily reined in over the past four years.

There will be more loosening to come. Vice Premier Liu He told the Lujiazui Forum in Shanghai on Thursday that Beijing has plenty of policy tools and is capable of dealing with its various challenges. This was widely taken to be signalling imminent further cuts in either interest rates or the reserve ratio requirements for banks. Liu also put a positive spin on the international pressures on China, saying they would force the pace of rebalancing of the economy and opening of the financial sector.

This Bystander is not holding his breath. The longer deleveraging is put off in the cause of maintaining GDP growth above target, the greater the debt burden grows, and the closer the day of financial reckoning becomes.

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Short-Term Stimulus Trumps Long-Term Risk

THERE IS MUCH to digest in the official reports of the annual Central Economic Work Conference just concluded in Beijing.

In short, every available policy tool will be thrown at stabilising slowing growth in the short-term while attempting to keep a clear eye on the long term goal of rebalancing and deleveraging the economy and establishing China’s greater role in global economic governance, the unstated part being that the successful execution of the long-term plan is what will ensure the Party’s continued monopoly on power.

For now, keeping the economic ship stable in turbulent waters in 2019 will demand bigger tax cuts, no tightening of monetary policy and easing as needed, particularly to keep liquidity flowing to small and medium-sized enterprises in the private sector, and a significant expansion of special-purpose local government bond issuance to pay for the old stimulus standby, more infrastructure investment.

This all adds up, if not to a full-blown stimulus package then at least a considerable expansion of this year’s targeted measures.

The downside is that it will slow the long-term structural reforms needed to move the economy up the development ladder and to defuse the country’s underlying debt bomb. The trade tensions with the United States are lengthening the fuse, and that may do more damage to the economy than tariffs themselves.

Deleveraging the economy while simultaneously stimulating it is a difficult balancing act, and the more so in a global economic environment that is more unpredictable and unfavourable to Beijing that any recent leadership has experienced.

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Latest China GDP Figures Show Stable But Challenged Growth

Screen Shot 2018-10-20 at 10.44.23 AM

IF THERE IS a scintilla of concern for authorities in the third-quarter GDP growth figure, covering July-September, it is that the tariffs imposed by the United States have not had much time to have a material impact.

At 6.5% year-on-year, the third-quarter number represents the slowest quarterly growth rate since the first quarter of 2009 in the immediate aftermath of the 2008 global financial crisis. However, it is still in line with the official growth target for the year. For the first nine months, GDP grew at an above-target 6.7%, according to the National Bureau of Statistics, which generally portrays the economy as “running within reasonable range in the first three quarters, and [continuing] to stay stable with good growing momentum”.

However, as the economists like to say, all the risks are on the downside: Trump’s tariffs; the ticking debt time bomb; and the pains of rebalancing.

In particular, with the Trump administration ramping up its tariffs in the current quarter and no resolution to the trade frictions between the two countries in sight, further policy support for the economy is going to be needed. However, policymakers’ scope to stimulate the economy is limited by high debt levels, in part taken on to finance the infrastructure investment boom that was the stimulative response to the 2008 financial crisis.

Giving banks more freedom to grow their loan books, trusting their credit judgements are better — or less politically swayed — than they have been in the past, will be preferred to increasing direct government spending. There will some of that, though, too, if growth is seen as slowing uncomfortably fast once the current round of US tariffs takes effect, or is followed by another.

Investors are less than convinced. Hence the raft of bullish statements from President Xi Jinping’s top economic adviser and the heads of the securities regulator, the combined insurance and banking watchdog and the central bank urging investors to stay calm as the main stock market index neared a four-year low.

However, the important words are yet to be spoken. Those will exchanged between Presidents Xi and Donald Trump when they meet at the G20 leaders’ summit in Buenos Aires at the end of November and may give an indication of which direction the trade disputes between the two countries are headed in.

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Anbang Nationalisation Underlines China’s Financial Stability Priority

Logo of Anbang Insurance Group. Photo credit: Mighty Travels. Licenced under Creative Commons.

WU XIAOHUI, THE politically well-connected chairman of the giant insurance group Anbang (his wife is Deng Xiaoping’s grand-daughter), has been in detention by authorities since last June. Now he is to stand trial for economic crimes, code for fraud and embezzlement, and the company run by personnel from the China Insurance Regulatory Commission for a year or two, an extraordinary move. The state assuming control of a private-sector business, and particularly one of this size and prominence, is unusual.

Anbang has been on an aggressive international acquisitions drive, buying such foreign trophy investments as the Waldorf Astoria in New York and a string of other luxury US hotels. Chinese firms, with official encouragement, have ‘gone global’ in recent years, rapidly expanding their international mergers and acquisitions activity.

In 2016, China overtook Japan to become the world’s second-largest overseas investor. Non-financial outward direct investment that year exceeded $170 billion, a 44% increase from the previous year, according to the Ministry of Commerce. However, such activity entails tremendous financial risk from the leverage taken on, a risk exacerbated by Chinese firms’ lack of experience with the integration and management challenges that M&A brings, especial in deals that cross national and cultural borders.

Anbang appears to fall squarely in this camp. On some estimates (its finances are notoriously opaque), it has encumbered itself with debt to the point that it is fast approaching technical bankruptcy despite having more than $300 billion of assets.

That also makes it ‘too big to fail’. State administration will provide the funding to keep its core life and non-life insurance business operationally solvent. The insurance regulator says the company’s current operations remain stable but that its solvency is seriously endangered by its ‘illegal operations’ unspecified but which presumably include its investments in prestige prime US real estate.

Last August, authorities announced a list of sectors hat should be off-limits for Chinese firms as the foreign investment spree into things like European football clubs and Hollywood entertainment businesses was exacerbating debt concerns.

More broadly, in the drive for financial stability and to forestall any systemic financial shocks, President Xi Jinping has been asserting greater control over state enterprises and reining in sprawling private conglomerates, notably the ‘big four’ — Angbang plus Dalian Wanda, Fosun International and HNA Group — that have expanded rapidly via debt-fuelled foreign acquisitions.

That quartet that accounted for 20% of Chinese foreign acquisitions in 2016. Also, there has always been a nagging suspicion that, given the quartet’s political connections, some of this M&A acted as a conduit for senior officials to get their money out of the country.

All have been ‘urged’ to sell assets and pay down their debt while state banks were told to rein in their lending to them. In January, the chairman of the Banking Regulatory Commission, Guo Shuqing, warned that ‘massive, illegal financial groups’ posed a grave threat to financial reforms and the stability of the banking system and that China would address the issue ‘ in line with the law’.

Taking Anbang into state control may be the prelude to a series of moves against the layer of private conglomerates below the ‘big four’, a group of some 25-30 companies said to be in the regulators’ sights. Despite or perhaps because of his connections, Wu’s treatment, in particular, is intended to show that no tycoon is immune from being ‘deterred’ from risky borrowing and investment overseas, or from being reminded that private M&A strategies should be integrated with national investment priorities.

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World Bank Ups Its Prospects For China’s Economy

THE WORLD BANK has become more bullish on China, at least for the near-term. In its newly published annual Global Economic Prospects, it has upped its estimate of GDP growth in 2017 to 6.8% (an 0.3 percentage point increase from its forecast a year ago and reiterated in June) and said it expects 6.4% growth this year (an 0.1 percentage point increase from its previous number).

China benefited, the Bank now says, from the recovery in world trade last year, fiscal stimulus and the rebalancing of the economy, which eased the drivers of the economy away from state-led investment. Inflation rose but was still within target and housing price increases moderated in response to policy measures.

The current account surplus continued to narrow, but the clampdown on capital outflows meant that exchange-rate pressures eased and foreign-exchange reserves recovered modestly.

On the flip side, non-financial sector debt continued to grow, reaching 260% of GDP, regardless of further monetary and regulatory tightening. Credit growth still outpaces nominal GDP growth.

The Bank says that financial sector vulnerabilities — particularly high corporate indebtedness in sectors with overcapacity and deteriorating profitability — are one of the key downside risks to growth.

Others include the possibility of protectionist policies in advanced economies (for which read the United States) and rising geopolitical tensions (for which read mainly North Korea).

The Bank also expects the economy to continue its measured deceleration, averaging 6.3% growth in 2019 and 2020, and less beyond that as adverse demographics kick in over the next decade.

A steeper-than-expected slowdown or debt- or geopolitical-driven financial stress would have impacts well beyond China’s borders.

The Bank’s view is that authorities have substantial ‘policy buffers’ to absorb financial shocks. Nonetheless, it, like others, calls for further structural reform to reallocate economic activity towards more productive sectors.

This would include financial and corporate sector reform as well as greater efforts to deleverage and improve the fiscal sustainability of provincial, municipal and local government.

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