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Wednesday, June 26, 2013

In the global economy there is one indicator that is widely used to understand the credit risk in a particular country. This is called the credit default swap (CDS) spread. CDS is essentially a financial agreement by which the seller of the agreement will compensate the buyer in case of a loan default or any other such adverse credit event. So if the CDS spread increases it means that the seller is demanding a higher compensation for providing the risk cover. Or that the risk of default is increasing. Therefore increasing CDS spreads is treated as an indicator of an upcoming credit crisis. And this indicator suggests that there is a trouble brewing in our neighbouring nation - China. Because the CDS spread for China has spiked by most since the collapse of Lehman Brothers. The spread has gone up by 55% over the past few days. This has many to wonder if the credit bubble created by China's shadow banking network is about to pop. The country has so many layers of financing other than its banks that it had sent credit risk in the country soaring. And as China slowed down in the wake of the global crisis, the credit risk posed by the multiple layers was getting worse. If the CDS spread increase is anything to go by, then the country is on a brink of a credit crisis. We all hope that the government would take all measures to prevent this from happening. But what if China has a financial crisis? Can the unstable global economy withstand such a blow? 

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