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SYDNEY. — The potential for financial pressure to further stall China’s growth should not be ruled out Reserve Bank assistant governor Chris Kent has said. “It’s possible to have a more substantial slowing in China that comes through the financial system problems that they might experience given they have high levels of debt,” Dr Kent told a panel at the UBS Australasia conference in Sydney yesterday.

Dr Kent said the weakness in the industrial sector was affecting certain regions in China more than others which could see regional lenders running into trouble. “The really big question is what the authorities do in response. Do they see it in a timely manner and how do they react?” Dr Kent said.

“There’s a question between the regional authorities versus the central authorities and the power to do a lot is at the centre.” Dr Kent and UBS China economist Donna Kwok said Chinese authorities had a range of fiscal and monetary policy tools to react to a financial crisis. However, Ms Kwok said China’s vulnerabilities to a financial crisis were negated by the fact that most of its debt was sourced offshore.

Of China’s 250 percent of debt to GDP around 10 percent is sourced externally with most of the internal credit extended by state-owned banks. “In the event that we do get a credit crunch, it will affect growth, however, the government has more than enough resources to be able to step in and make liquidity injections into the banking system to resume lending.”

Ms Kwok said China will eventually have to confront its debt build-up as deflation increases the real costs of servicing that build-up. She forecasts that by 2020, it will embark on a “prolonged and painful” de-leveraging process.

There was no Chinese financial crisis in 2000 even though non-performing loans accounted for one-third of all banking assets, Jacob Mitchell of Antipodes Partners pointed out. But the banking system is substantially larger and there will be more pressure on the banks, he said.

Mitchell, the former deputy chief investment officer of Platinum Asset Management, said that it was “naive” to believe the broader global financial system was insulated from China’s growth challenges.

“A US$28 trillion banking system that starts to come under pressure and a country which is the second largest owner, after the Federal Reserve, of US debt, to think the linkages are not real, back into the global financial system, is naïve.” Investors in Chinese stocks should be prepared to accept that companies they own may be called up for “national service. ” he said.

“When you’re looking at a Chinese stock don’t be surprised if one day that company has to buy a bond issue or an equity injection into an unrelated entity. I think to protect yourself, you need to be selective in the financial sector. Those weak banks which were 30 percent of the system are 45 percent of the system today. They will end up being part of the big four banks over time,” said Mr Mitchell. – Financial Review.