China’s stabilizing growth has eased some of the anxiety that rattled investors in early 2016. But it is partly the result of returning to an old habit: hefty lending to national and local state-owned enterprises (SOEs). China’s private debt-to-gross domestic product (GDP) ratio has surged to more than 200%. Never has a big economy piled up so much debt so quickly, as the chart below and related interactive graphic show.

chart-credit-conumdrum-v2

Credit binges in the past often led to busts. Yet China is different in some ways. Thanks to its large domestic savings rate, it has little external debt—the original sin that has sparked many emerging market (EM) crises. Beijing is working on fixes for internal debt issues, such as turning short-term bank debt into long-term bonds and redirecting credit to the private sector and households. But ultimately, China needs to find more sustainable engines of growth beyond further debt accumulation by unproductive national and local SOEs, or accept slower growth.

This is a difficult balancing act: The longer China delays attacking the problem head-on, the greater the risk of accidents.

Rising global rates and a stronger U.S. dollar are creating additional challenges for China. They are leading to capital outflows and a drain on reserves, as the central bank tries to resist downward pressure on the yuan. This is contributing to higher local interbank rates, which can hurt growth over time.

Speculation may build that authorities will allow a one-off large currency devaluation to stem capital outflows. This would likely have knock-on effects on other EM currencies and asset prices. We expect a further gradual decline in China’s currency against the U.S. dollar in 2017, but a large devaluation is not our base case.

We are on the lookout for any signs of stress such as greater capital outflows or disruptions in China’s fixed income markets. Increased trade frictions would also intensity the risk to our outlook for China and EM assets in general. Read more in our 2017 outlook.

Isabelle Mateos y Lago is BlackRock’s Chief Multi-Asset Strategist. She is a regular contributor to The Blog.

Investing involves risks, including possible loss of principal. International investing involves special risks including, but not limited to currency fluctuations, illiquidity and volatility. These risks may be heightened for investments in emerging markets.

Past performance is no guarantee of future results.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of January 2017 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

©2017 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

Investopedia and BlackRock have or may have had an advertising relationship, either directly or indirectly. This post is not paid for or sponsored by BlackRock, and is separate from any advertising partnership that may exist between the companies. The views reflected within are solely those of BlackRock and their Authors.

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.