China’s GDP grew a respectable 6.9% in 3Q15, at least according to the government (which lowered its growth target for the next 5 years to 6.5%).

However, other statistics, like exports and imports as well as PMIs, paint a bleaker picture of the Chinese economy, whereas banks reported higher NPLs in 3Q15 (stated NPL is 1.6% but real number could be as high as 15%) and are talking to regulators about lowering loss reserve requirements. Many analysts are claiming that China is transforming its economy from a low-cost manufacturing export-driven model to a more balanced model that includes a significant services component (“dining over mining”), driven by urbanization over the last couple of years. Although this is true to a certain extent (not all services, like banking and real estate, are necessarily healthy), it seems that China’s leaders are rather nervous about this transformation and keep on stimulating the economy whenever there is some headwind (for example, there have been 6 rate cuts since November 2014 whereas bank debt in 3Q15 rose by 15.4% year over year).

Structural reforms to address overcapacity and the stranglehold of bloated and inefficient state-owned enterprises on economic resources are implemented half-heartily. Meanwhile, China’s overall debt is rising, in the last year especially manifesting itself in a buoyant local bond market, and outstripping GDP growth: total debt to GDP is estimated at 240% (up from 160% in 2005).

Although China has the means to deal with a debt crisis (with foreign reserves of USD 3.3 trillion as of 31 December, according to the PBoC), the longer the government postpones structural reforms (which have much to do with incentivizing efficient allocation of capital instead of blowing asset bubbles as now is happening in, for example, the property sector) the more pressure builds up in the system and the more likely a sudden stop becomes.

This is aggravated by Beijing’s inclination to defy market gravity, as we again saw in the new year when the Shanghai stock exchange dropped by 10% in the first days of January, by supporting share prices through indiscriminate share-purchase programs and outlawing share sales (let alone shorting stock) or even talking about weakening stock markets in the press, thereby increasing moral hazard in the economy. As the Chinese leadership is reluctant to let companies in industries with substantial overcapacity go broke in fear of social unrest, the focus on exports has intensified. Steel companies from the U.S. and Europe are fuming about alleged dumping of steel products by their Chinese competitors and are calling for steep import tariffs.

Meanwhile, the yuan weakened against the dollar (but not against the euro), albeit at a modest rate of 5% in 2015 (and another 2% this year). Although we don’t think that this devaluation was driven by a desire to increase competitiveness, the Chinese authorities could contemplate further devaluations to stimulate exports (to support zombie companies) in order to contain social discontent (unemployment). This could set off a round of competitive devaluations in the region, which could destabilize the global economy, starting with China itself. So far, investors in credits markets seem sanguine about China, despite the sell-off in equity markets in 2016.