HONG KONG/TOKYO (BLOOMBERG) - It used to be that when America sneezed, the world caught a cold. This time around, it is the risk of a poorly China that poses a bigger risk.
The world's second-largest economy is now trying to ward off the sniffles. While output is still growing at a pace that sees gross domestic product (GDP) double every decade, the problem remains that much of that has been fuelled by a massive build-up of credit.
Total borrowing climbed to about 260 per cent of the economy's size by the end of 2016, up from 162 per cent in 2008, and will hit close to 320 per cent by 2021, according to Bloomberg Intelligence (BI) estimates. Economy-wide debt levels are on track to rank among "the highest in the world", according to Tom Orlik, BI's chief Asia economist.
That path may be what prompted outgoing People's Bank of China governor Zhou Xiaochuan to warn of the risk of a plunge in asset values following a debt binge, or a Minsky Moment, earlier this month. Given that China is forecast by the International Monetary Fund to contribute more than a third of global growth this year, controlling China's debt matters far beyond its borders.
There are two key components of China's credit clampdown, each posing challenges to policymakers.
First is wringing out bets on property prices.
As President Xi Jinping put it in a keynote policy speech to the Communist Party leadership on Oct 18: Housing is for living in, not for speculation.
The latest data shows that in some areas, prices are still surging in many cities despite a raft of measures to make it harder for investors to buy real estate with borrowed money. Xi'an, China's ancient capital, saw home values soar almost 15 per cent in September from a year before.
It will be up to regulators to come up with measures that deliver on Xi's mandate without tipping housing into a downward spiral. Property crashes in the US, Japan and Britain over the past three decades amply illustrated how damaging they can be to economies.
The second key challenge is progress in aligning borrowing costs with borrowers' ability to repay - rather than with their relationship with the state.
China's financial system has long let companies that are state owned or are seen to be implementing state initiatives get funding more cheaply than others.
That is thanks to the assumption that the government would step in if needed to back them up. To help encourage capital to be deployed more efficiently - and to prevent firms that are effectively insolvent keep going thanks to continued funding - policymakers have begun to gradually take away implicit support.
In 2014, solar-panel maker Shanghai Chaori Solar Energy Science & Technology became the first Chinese company to default on a domestic corporate bond.
Since then, even some state-owned firms have been allowed to default. Handling that process is delicate.
"If tomorrow you suddenly withdraw that implicit government support, you would get a freeze-up in credit flow," said Kenneth Ho, head of Asia credit strategy research at Goldman Sachs Group in Hong Kong.
"If they do it too quickly, the system will collapse. They've been going at the right speed."
Ho anticipates that the number of defaults allowed will go up, though he does not see any surge. "We're in an upward cycle in terms of recognising defaults, but it's a long cycle," he said.
To be sure, China's economy continues to defy predictions of an actual debt crisis or a housing bust.
Instead, there are signs of a controlled easing. Home prices in September rose in the fewest cities since January 2016, amid curbs on debt-fuelled buying.
A domestically triggered crisis is unlikely, at least in the next five years, according to a report by Berlin-based Mercator Institute for China Studies.
"Trouble is more likely to come from some combination of capital flight and sudden withdrawal of external credit," wrote Victor Shih, a professor at the University of California at San Diego and author of the report.
Still, few countries that have experienced China's pace of debt growth have unwound things without some sort of crunch.
Investors, companies and governments around the world will want China to break that mould. An indication of the ripple effect China can have on global markets came in 2015 when a devaluation of the yuan, followed by other changes to how the tightly controlled currency is traded, sent shock waves through global markets.
The move triggered capital to flow out of China, forcing the authorities to burn through reserves to support the currency.
While China's policymakers are preaching the commitment to tackle debt, not everyone is convinced. Some analysts say the authorities are not going hard enough."There is no deleveraging," Luke Spajic, head of portfolio management for emerging Asia at Pacific Investment Management, said at The New Renminbi Reality Summit organised by Bloomberg Live in Singapore.
"Debt to GDP is going up rather than down," he said.
"Certain pockets of the economy have been forced to bring leverage down, but in general this is a story of debt growth."