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VOL. 10, NO. 1 • JANUARY 2015

DALLASFED

Economic
Letter
Current Account Surplus May Damp
the Effects of China’s Credit Boom
by J. Scott Davis, Adrienne Mack, Wesley Phoa and
Anne Vandenabeele

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ABSTRACT: In contrast to
similar credit expansions in the
euro periphery in the 2000s
and East Asia in the 1990s,
China’s credit boom is far less
likely to end in a dramatic
bust because it’s financed by
domestic savings.

nalysts and the financial press
have scrutinized the buildup
of private sector borrowing in
China over the past few years.
Debt accumulation seems eerily familiar
to what occurred in past credit booms,
most notably in the euro zone periphery in the mid-2000s and in East Asia a
decade earlier.
There was no buildup of leverage
in China prior to the global financial
crisis in 2008, though there was a rapid
rise in leverage afterward, mainly the
result of government investment-led
stimulus efforts that drove China’s postcrisis recovery. The major banks in
China are state owned, and the government directed them to increase lending
in the dark days of the global financial
crisis to drive a credit-fueled investmentled recovery.
At the time of Lehman Brothers’
September 2008 collapse, which partially
precipitated the global financial crisis,
the ratio of private nonfinancial credit to
gross domestic product (GDP) in China
was 110 percent. Five years later, the ratio
was 178 percent, greatly exceeding financial crisis levels experienced in the euro
zone periphery, where it rose from 113
percent in 2003 to 160 percent of GDP in
2008.

Over that same period, the ratio of
private nonfinancial credit to gross GDP
in the U.S. rose from 141 percent to 168
percent, while in the core of the euro zone,
the ratio increased from 138 percent to 142
percent (Chart 1).

Previous Financial Crises
The ratio of private sector credit to
GDP in China has increased 67 percentage
points since 2009 (Chart 2). This ratio has
grown less than 3 percentage points in the
rest of the world since then.1
Periods of rapid credit expansion in
recent decades have often been followed
by financial upheaval. Chart 2 also presents
credit growth in the countries involved in
the East Asian financial crisis in the 1990s.
Over the five years preceding that crisis, the
credit-to-GDP ratio increased 38 percentage points.2 Meanwhile, in the rest of the
world, credit growth was less than 5 percentage points.
Similarly, in the five years leading up
to the global financial crisis, the private
sector credit-to-GDP ratio in the U.S. grew
27 percentage points, the ratio in the U.K.
expanded 25 percentage points and the
ratio in the euro zone periphery swelled
47 percentage points. By comparison, euro
zone core private sector credit grew 4 percentage points between 2003 and 2008.

Economic Letter
At first glance, it may seem as if China
is heading for the same type of disaster that
befell the euro zone periphery. But there is
one major difference between China today
and these past episodes. The past credit
booms all occurred in countries running a
current account deficit, meaning the credit
boom was financed from foreign borrowing. China, conversely, is running a current
account surplus, meaning that China’s
credit boom is financed from domestic
savings.

Importance of the Current Account
Researchers can quantify the effect
of this credit growth on the probability of
a banking crisis. The statistical or model
approach is particularly useful since other
potential determinants of a banking crisis
can be factored into the analysis.
To gauge the impact of a high rate
of credit growth on the probability of a
subsequent banking crisis, we use data
for a large panel of countries to model the
incidence of banking crises, controlling for
a range of economic factors as well as the
growth in credit.
Specifically, we consider statistical
relationships. We regress a variable for the
incidence of a banking crisis in a given
year and a given country on that country’s
excess credit growth over the previous
five years and other country-specific variables. These variables include the current
account surplus or deficit (whether the
country is a net creditor or debtor) as a
ratio of GDP, the output gap (the difference between what a country produces
and its theoretical potential), the inflation
rate and whether the country has a fixed
or floating currency.
The estimated credit-to-GDP coefficients from this regression may be
interpreted as the “marginal effect” of an
increase in the credit-to-GDP ratio on the
probability of a banking crisis—that is, an
estimate of the change in the probability
of a banking crisis resulting from a 1 percentage-point increase in the private sector
credit-to-GDP ratio.3
Two scenarios for estimating the effect
of credit growth on the probability of a
banking crisis may provide insight.
In the first, there is no interaction
between credit growth and a country’s
current account surplus or deficit. Credit
growth is just as likely to lead to a crisis

Chart

Private Sector Credit as a Share of China’s GDP Jumps

Private nonfinancial sector credit-to-GDP ratio (percent)

200.6
180.6
160.6
140.6
120.6
100.6

Euro-area periphery
China
U.S.
Euro-area core

80.6
60.6
40.6
20.6
0.6

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

SOURCES: “How Much Does the Private Sector Really Borrow—A New Database for Total Credit to the Private NonFinancial Sector,” by Christian Dembiermont, Mathias Drehmann and Siriporn Muksakunratana, Bank for International
Settlements Quarterly Review, March 18, 2013; Haver Analytics; authors’ calculations.

Chart

China’s Private Sector Debt Increase Outpaces Rest of World

Debt-to-GDP ratio (percent)
80
70
60
50
40
30
20
10
0

China
’09–’13

All other East Asia All other
countries ’93–’97 countries
’09–’13
’93–’97

U.K.
’03–’07

U.S.
’03–’07

Euro-area Euro-area
core
periphery
’03–’07 ’03–’07

whether that credit was financed at home
or abroad.
In the second specification, the possibility of an interaction between credit
growth and the current account is permitted and may produce different results
depending on whether the current account
is in surplus or deficit. By allowing for this
interaction, the marginal effect becomes
a function of a country’s current account
balance.
The current account is equal to
domestic savings minus domestic investment, so if the current account is in
surplus, domestic savings can more than

finance any domestic investment. If it
is in deficit, domestic savings are insufficient to finance domestic investment,
and foreign borrowing is necessary.
Previous crisis episodes suggest that
domestic savings tends to be a more
stable form of financing than foreign borrowing. Foreign lenders are much more
likely to withdraw their financing and
refuse to roll over existing debt, and thus
the possibility that high credit growth
may frighten investors and trigger a run
on a country’s financial system is much
more likely when credit growth depends
on foreign financing.

Economic Letter • Federal Reserve Bank of Dallas • January 2015

Economic Letter
Banking Crisis Risk
Estimates of the marginal effect of
credit growth on the probability of a banking crisis under these two specifications
are presented in Chart 3. When interaction
between credit growth and the current
account isn’t allowed, the effect is constant and equal to 0.14—in other words,
a 10 percentage-point increase in the
credit-to-GDP ratio over a five-year period
should raise the probability of a banking
crisis by about 1.4 percentage points.4
When interaction between credit
growth and the current account is
allowed, the marginal effect varies negatively with a country’s current account
balance. It is smaller in countries with
a current account surplus and higher in
countries with a current account deficit.
For a country with a balanced current
account, the estimated marginal effect
is around 0.16. For a country with a current account surplus of 5 percent of GDP,
this marginal effect is only 0.03, but for a
country with a current account deficit of
5 percent of GDP, it is around 0.30—a 10
percentage-point increase in the credit-toGDP ratio over a five-year period should
raise the probability of a banking crisis by
about 3 percentage points.5
Thus, the estimates from this statistical model suggest that a credit boom
financed from domestic savings is much
less likely to end in a banking crisis than
a credit boom financed from foreign
borrowing.
Growth of the private sector creditto-GDP ratio, the previous year’s current
account balance (as a percentage of GDP)
and the estimated effect of that credit
growth on the probability of a crisis are
shown in Table 1. The impact is calculated
under two specifications, with and without an interaction between credit growth
and the current account.
The euro zone periphery countries
that experienced growth in the private
sector credit-to-GDP ratio of 47 percentage points before the financial crisis also
ran a current account deficit of 5 percent
of GDP in 2006. Without allowing for an
interaction between credit growth and the
current account, each percentage point
of credit growth should have increased
the probability of a banking crisis by 0.14
percentage points. If that marginal effect
is multiplied by the 47 percentage points

Chart

Probability of Crisis Grows as Current Account Falls into Deficit

Marginal effect of credit growth

.5
.45

Current account interaction

.4
.35
.3
.25
.2

No current account interaction

.15
.1
.05

0
–10 –9 –8 –7 –6 –5 –4 –3 –2 –1 0 1 2 3 4 5 6
Deficit
Surplus
Current account balance (as a percentage of GDP)

Table

Probability of Banking Crisis in China Is Low
Effect of credit growth on the
probability of a crisis
(in percentage points)
Credit growth
(in percentage
points)

Current account
balance (as a
percentage of
GDP)

No current
account
interaction

With
current
account
interaction

East Asia, 1993–97

38.2

–4.4

+5.3

+10.7

U.S., 2003–07

27.3

–5.8

+3.8

+8.7

U.K., 2003–07

24.9

–2.8

+3.5

+6.0

4.1

+3.6

+0.6

+0.3

Euro periphery, 2003–07

47.4

–5.2

+6.6

+14.2

China, 2009–13

67.6

+2.6

+9.5

+6.1

Euro core, 2003–07

of credit growth, that credit growth should
have increased the probability of a crisis in
the euro zone periphery by 6.6 percentage
points. However, when the model includes
an interaction between credit growth and
the current account, the estimated marginal effect is 0.30—in this instance, 47
percentage points of credit growth raised
the probability of a crisis by 14.2 percentage points.
China has experienced more growth
in the private sector credit-to-GDP ratio
in the past five years than did the euro
zone periphery between 2002 and 2007,
the table shows. If we did not take into

account the interaction between credit
growth and the current account, China’s
recent credit would raise the probability
of a crisis by 9.5 percentage points.
However, China has a current
account surplus of over 2 percent of
GDP. When accounting for the effect of
this surplus, each additional percentage
point of credit growth in China should
only lead to a 0.09 percentage-point
increase in the probability of a crisis.
Thus, according to these estimates,
China’s credit boom should have raised
the estimated probability of a crisis by
only 6.1 percentage points.

Economic Letter • Federal Reserve Bank of Dallas • January 2015

Economic Letter

Possible Instability Sources
These results suggest that credit
growth and the extent to which it is
financed abroad affect the probability
that a country will face a banking crisis.
China, unlike most countries that experienced banking crises in recent years, has
a current account surplus that makes its
credit boom less dangerous. The model
of banking crises predicts that the effect
of credit growth on the likelihood of a
crisis should depend on whether that
credit growth is financed at home or
abroad.
It also suggests that each additional
percentage point of credit growth in
China should raise the likelihood of a
banking crisis by about 0.16 percentage
points. Credit growth is estimated to
have boosted the probability of a banking
crisis by more than 6 percentage points
in 2013.
However, the probability of a banking
crisis is rising due to the recent acceleration in leverage and the deterioration in
China’s current account surplus. The surplus has fallen steadily from its peak of
10 percent of GDP in 2007 to about 2 percent in 2013. Should the current account
go into deficit, the probability of a banking crisis will increase significantly. This
suggests that while a banking crisis may
not be imminent, the risk of financial
instability in China is rising.

DALLASFED

Davis is a senior research economist and
Mack was a senior research analyst in
the Research Department of the Federal
Reserve Bank of Dallas. Phoa is a partner
and portfolio manager, and Vandenabeele
is an economist at Capital Group Cos.

Notes
The rest of the world includes Argentina, Australia,
Austria, Belgium, Brazil, Canada, China, Czech Republic,
Denmark, Finland, France, Germany, Greece, Hong Kong,
Hungary, India, Indonesia, Ireland, Italy, Japan, Malaysia,
Mexico, the Netherlands, Norway, Poland, Portugal,
Russia, Saudi Arabia, Singapore, South Africa, South
Korea, Spain, Sweden, Switzerland, Thailand, Turkey, the
U.K. and the U.S. Data on the stock of private nonfinancial
sector credit are available from the Bank for International
Settlements and described in “How Much Does the Private
Sector Really Borrow—A New Database for Total Credit to
the Private Non-Financial Sector,” by Christian Dembiermont, Mathias Drehmann and Siriporn Muksakunratana,
Bank for International Settlements Quarterly Review, March
18, 2013.
2
East Asia refers to a GDP-weighted average of Indonesia,
Malaysia, Singapore, South Korea and Thailand. The
euro-area core refers to Austria, Belgium, Finland, France,
Germany and the Netherlands; the euro-area periphery
refers to Greece, Ireland, Italy, Portugal and Spain.
3
Banking crises are fairly rare events. The unconditional
probability of a banking crisis in our dataset is 4 percent.
Additionally, crises are driven by many factors that are
outside the reach of this or any other statistical-based
predictor model. However, models can still be effective for
measuring the probability of a crisis and the effect of certain
1

Economic Letter

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of Dallas or the Federal Reserve System.
Articles may be reprinted on the condition that
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Economic Letter is available on the Dallas Fed
website, www.dallasfed.org.

variables on the probability of a crisis, as shown by diagnostic tests in “Credit Booms Gone Bust: Monetary Policy,
Leverage Cycles, and Financial Crises, 1870–2008,” by
Moritz Schularick and Alan M. Taylor, American Economic
Review, vol. 102, no. 2, 2012, pp. 1029–61.
4
This estimated marginal effect of credit growth is similar
to that found in Schularick and Taylor. See note 3.
5
The details about these regressions can be found in
“Credit Booms, Banking Crises, and the Current Account,”
by J. Scott Davis, Adrienne Mack, Wesley Phoa and Anne
Vandenabeele, Federal Reserve Bank of Dallas, Globalization and Monetary Policy Institute Working Paper no. 178,
May 2014. The regressions are run using a panel of 35
countries. The data for most of the developed countries
in the sample start in the 1970s; the data for China begin
in 1985. The results presented here are specifically those
from the linear probability (OLS) model in Table 8.

Mine Yücel, Senior Vice President and Director of Research
Anthony Murphy, Executive Editor
Michael Weiss, Editor
Kathy Thacker, Associate Editor
Ellah Piña, Graphic Designer

Federal Reserve Bank of Dallas
2200 N. Pearl St., Dallas, TX 75201

Full text of Economic Letter : Insights from the Federal Reserve Bank of Dallas : Current Account Surplus May Damp the Effects of China's Credit Boom, Volume 10, Number 1

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