IMF financial crisis indicator bodes ill for China
By Christopher Swann
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
The International Monetary Fund has a new crystal ball of sorts. The lender has found a measure of credit growth that could predict crunches. It makes China look precarious and heralds turbulence elsewhere, too.
The IMF’s crisis-spotting record is lousy. Ever since the global financial meltdown in 2008, it has been under pressure to get better at spotting troubles ahead of time. Despite its army of PhDs, the fund was blindsided by the U.S. subprime mortgage crisis and downplayed the problems even as they started to unfold.
So in this year’s Global Financial Stability Report, released on Wednesday, the IMF offers a new risk warning light. An annual increase in the ratio of a nation’s outstanding credit to its GDP of more than five percentage points, the IMF reckons, signals a heightened risk of financial crisis about two years thereafter.
Had the IMF followed this simple rule of thumb, it might have foreseen not only the U.S. excesses at the heart of the crisis in 2008 but also the woes in Greece, Italy, Portugal and Ireland.
The IMF isn’t naming names but at the moment, based on data compiled by Thomson Reuters, the indicator is blinking red for China, where the credit-to-GDP ratio rocketed 24 percentage points in 2009 — putting the nation on track for turbulence any time now, though the increase last year was just four percentage points. White-hot credit growth in Hong Kong, where the IMF’s ratio ballooned by 30 percentage points last year, looks alarming. Among other more significant economies, Turkey and Vietnam also registered well above the fund’s threshold last year.
That said, the IMF is rightly careful not to overstate the reliability of its 5 percent rule. Brazil flashed red in 2006, 2007 and 2008, but a financial crisis hasn’t happened yet. There are also other trends that tend to presage busts, like surging capital inflows. There’s a further danger the indicator could succumb to Goodhart’s law, which states that once anyone starts relying on a metric it stops being useful.
Still, the yardstick does express a warning that borrowing is expanding significantly faster than the growth of an economy as a whole. It won’t work perfectly, but the stewards of overheating economies shouldn’t dismiss what seems a sensible metric.