Article last updated 22 July 2025.
Ed Smith says: “While India may be the ‘new China’ for some investors, given it is where China was in terms of growth at the start of the new millennium, China is to remain the largest Asian growth engine over the next 20 years, and should continue to command investors’ attention. Given the relative size of the two economies today, it would still take over two decades for India’s GDP to exceed China’s, even if India achieves all of its much needed reform and China achieves very few. Of course, that doesn’t mean that the Chinese stock market will automatically perform better, but it is important to bear in mind the stark difference in size when thinking about allocating capital.”
He adds that while India still has a decent demographic dividend, demographics will actually detract from growth in China.
“There’s scope for capital deepening in both countries. But in China it will be curtailed by excess debt and overinvestment in state-owned industrial sectors; in India there is a dysfunctional banking system and excessive red tape. Reform and productivity growth is key.”
In recent months levels of debt in China have caused concern for some investors. However, Ed thinks that the risk of a debt crisis is low.
“There is no crisis. China is not your typical emerging market ‘problem’, so we are much more sanguine than many of our peers about the level of debt in China and its neighbours. For sure, we expect that past excesses will reduce new growth and lending to productive projects for years to come, but a significant policy-induced slowdown seems unlikely. President Xi is acknowledging that high debt levels pose a risk for future growth, and he remains committed to doubling GDP per capita by 2020. To achieve this, Beijing must balance the amount of reform and deleveraging it can undertake, while maintaining an annual growth rate of 6.3%.
“Politburo member Liu He told Davos that Chinese reform will exceed Western expectations this year. Another top brass, Fang Xinghai, warned that there was too much debt in the system, but that the new super regulator would swoop in if there was any hint of systemic collapse. The quid pro quo is weaker credit growth and that already seems to be weighing on activity. Our measure of the credit ‘impulse’ in China has fallen back to zero. Our ‘nowcast’ of the underlying rate of economic growth rolled over in Q4 – the biggest quarterly fall since it began to trend up again in 2015. It’s too early to call a new trend, but this is something we’re monitoring closely.”
As it stands, Smith expects global economic and financial conditions will ensure emerging market equities have another good year, even though the Chinese economy may soften as a result of financial tightening, a weak property market and industrial restrictions to curb pollution.
“Contrary to popular wisdom, emerging market equities have previously outperformed during past Fed rate tightening cycles. We expect this to happen again unless their currencies start to weaken significantly, but again that’s not our base case.”
Notes to editors
Ed Smith highlights three reasons as to why he thinks there is a low risk of a debt crisis:
1. Most of China’s debt is funded with domestic capital and so questions over debt sustainability do not translate into a balance of payments crisis, like those experienced in Asia in the late 1990s (capital controls also help!). China is still a net lender to the rest of the world, with a gross national saving rate of 45% (10-20% is the norm in developed markets).
2. Loans from domestic banks are largely funded with deposits. Remember, one of the causes of the global financial crisis in the West was that bank loans greatly exceeded deposits. The shortfall was plugged by fickle interbank loans, which are more likely to be withdrawn in a hurry than household savings accounts. In China, the debt to deposit ratio is just 80%, compared to about 125% in the US during the financial crisis. Indeed, in April, the Chinese regulator banned banks from obtaining over a third of their funding from interbank lending.
3. Most of China’s debt has been issued by state-owned banks to state-owned firms and local government entities. Defaults can be averted by shifting money from the left pocket to the right pocket. If the government were to expropriate the bad debt from this scenario on to its balance sheet in one big, overnight clean-up, its debt to GDP ratio would still be lower than that of most G7 members!
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Edward Smith is Head Asset Allocation Strategy, Rathbones. His views are his own and are not to be taken as investment advice. The information contained in this note is for use by investment advisers and journalists, and must not be circulated to private clients or to the general public.
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