Talk of China's debt risk is all the rage in the international financial market. Both the IMF and the International Investment Bank count it high. If the Chinese government does not treat it seriously or fails to find a good solution, it could trigger systemic risks in China's financial market.
A latest IMF report about financial stability studied 2,871 Chinese non-financial companies and found that 590, or 20 percent, of them were facing financial risks. It thus estimates that the potentially risky debts on China's commercial banks' financial sheets may have exceeded $1.3 trillion.
The Bank for International Settlement estimates that China's aggregate debt-to-GDP ratio is 249 percent, of which corporate debt is 170 percent, government debt is 40 percent and household debt is 39 percent. Macquarie analyst Viktor Shvets puts China's total debts at $35 trillion with an aggregate debt ratio of 350 percent. This probably stems from the excessive increase in the number of “zombie” companies in recent years.
Nobel economics laureate Michael Spence says that the recent increase in international deliberation on China's debt unsustainability is normal, for too much debt would seriously impact the national economy, rendering it weak. For instance, the McKinsey Global Institute released a report on the post-crisis trend of debt growth. The report notes that the world's total debt has increased by $60 trillion since 2008 and China's debt tripled since 2007 with a total debt ratio reaching 282 percent, higher than most other major economies in the world. Spence argues that it is rather dangerous for a country's leverage ratio to rise too fast, for that may make it impossible to generate enough demand to stimulate economic growth.
Different institutions and researchers may come to different conclusions about China's debt risk as they approach the problem from different angles. Therefore, Chinese scholars may dismiss as insignificant the aforementioned researchers' assessment of China's debt risk, saying that it is nothing but an unfounded worry. Some competent government departments even regarded the international rating services' downgrading of China's sovereign debt credit as negligible, arguing that the international market doesn't really know China and that China's debt risk is not as high as suggested.
However, it may prove to be too early to state so, given the following facts.First, the Chinese central bank's balance sheet size grew 2.6 times from 2006 to the end of 2014, larger than that of the Federal Reserve in both absolute and relative amounts. Meanwhile the credit expansion of China's commercial banks reached an unprecedented high. The total credit amount in the five years from 2009 to 2013 exceeded the cumulative amount of the previous 60 years. And the expansion went even more unbridled in the first quarter of this year, with the total amount of social financing, bank credit and individual housing mortgage all growing to a record high. The whole society is experiencing an unprecedented credit expansion.
Second, the total assets of China's banking industry increased from the 62 trillion yuan at the end of 2008 to 203 trillion yuan at the end of March 2016, representing a triple growth in just seven years or an annual growth of over 17 percent. The growth rate even reached 27 percent in 2009. The growth of the banking industry's total assets usually comes in the form of fast expansion of credit, which may lead to bad loans. In fact, the problem of bad loans in domestic banks began to surface last year as China's economic growth slowed, with many industrial sectors suffering overcapacity and more state-owned-enterprises becoming “zombie businesses”.
The third fact is the explosive growth of the corporate bond market with troubles and risks continuing to emerge. Starting from April, China has entered the peak period of corporate bonds becoming due. By the end of this year, a record 4.12 trillion yuan in corporate bonds will be due. By now, 17 corporate credit bonds have defaulted. This may involve more than 100 financial institutions in the corporate debt crisis. Improper handling of these debts may also trigger a massive outbreak of risks in China's financial system.
To make things worse, the majority of bank loans have flown into the real estate market and most of the mortgage loans are related to this market. These loans are quality assets in a booming real estate market so long as there is no sign of housing prices plummeting. Once the bubble bursts, all real estate-related debt risks will erupt.
While the debts increase, people's confidence in private enterprises is dwindling, money movement is slowing down and companies are suffering declining productivity and diminishing profit, aggravating the deceleration of the national economic growth. China's economy is in a dilemma and pressured by both problems of growth slowing down and population aging. Only by totally abandoning the current growth model of relying on credit investment and the real estate industry, can China's economy get out of the dilemma. (An article published in People's Daily on May 9 suggests this new understanding, but there is no sign of it being translated into policy.) Otherwise, the debt risks in China's economy would become worse. The current government hopes to mitigate the debt risks through certain technical methods, such as replacement of local government debts, corporate debt-to-equity swap and debt securitization. These methods, however, won't do.
