China has had a 35-year addiction to cheap credit. The 2007/2008 global financial crisis and the resulting rare synchronous recessions in the developed world exposed China’s economy, especially its export sectors, to a large external demand shock – slowing growth. The recovery has been driven by a significant expansion in credit (known as TSF – total social financing).
Post-crisis, new lending by Chinese banks has been consistently about 30 per cent or more of GDP. About 90 per cent of this lending was directed towards investment in building, plant, machinery and infrastructure, especially by state-owned enterprises. According to the World Bank, almost all of China’s growth since 2008 has come from “government-influenced expenditure”.
This expansion led to a rapid increase in the level of debt. Most estimates now put Chinese government (including local government), corporate and household debt at about 200-250 per cent of GDP, up from about 140-150 per cent in 2008.
According to a 2013 report by China’s National Audit Office, Chinese government debt, including local government debt, is about 55 per cent of GDP –about $5 trillion (£3 trillion) – an increase of about 60 per cent from 2010.
But the official Chinese government debt figure may not be complete, as it may exclude debts from local governments and central departments outside the finance ministry. If these items are included, China’s government debt including contingent liabilities would be higher, perhaps 90 per cent of GDP.
There has been a parallel increase in private sector debt. Corporate debt has increased sharply, approaching 150 per cent of GDP. Traditionally considered compulsive savers, Chinese households have increased borrowing levels from about 20-30 per cent to 40-50 per cent of GDP. Inflation has driven increases in household borrowing, with sharply higher home prices requiring greater borrowings and devaluation of purchasing power encouraging debt-fuelled consumption.
China’s overall debt is high, especially when benchmarked against comparable emerging markets. Many Asian emerging markets had lower debt and higher per capita GDP before the Asian monetary crisis of 1997/1998.
The rapid rate of increase in debt is also seriously concerning. An increase in debt of about 30 per cent of GDP in five or less years is regarded as problematic. Several economies – Japan in the late 1980s, South Korea in the 1990s, not to mention the US and UK in the early 2000s – experienced similar rapid growth rates in credit, resulting in serious financial crises.
Another measure is the credit gap – the difference between increases in private sector credit growth and economic output. Research studies have found that 33 countries with credit gaps experienced a subsequent rapid slowdown in growth, typically by at least 50 per cent. In China, the credit gap since 2008 is over 70 per cent of GDP.
Chinese credit intensity (the amount of debt needed to create additional economic activity) has increased. China now needs about $3-$5 to generate $1 of additional economic growth, although some economists put it even higher, at $6-$8. This is an increase from the $1-$2 needed for each dollar of growth 8 to 10 years ago.
In China, debt has primarily financed investment but increasingly funded purchases of existing assets, which does not add directly to economic activity. Investment in new assets is heavily focused on frequently large-scale infrastructure and property. The major concern is that many of the projects will not generate sufficient income to service or repay the borrowing used to finance the investment.
Increased debt-fuelled investment in dubious projects reflects the need of ambitious government officials, especially in the provinces and at the municipal level, to meet centrally set growth targets. As Yuan Zhou, then mayor of Guiyang, capital of the South-western province of Guizhou, stated in a radio interview in 2011: “We need to struggle for GDP. Only with higher GDP will people’s lives be improved.”
The increased level of debt and the often uneconomic projects financed has led to increasing concern as to whether that debt can be serviced.
A 2012 Bank of International Settlements research paper on national debt servicing ratios found that a measure above 20-25 per cent frequently indicated heightened risk of a financial crisis. Analysts have estimated that China’s debt servicing ratios may be about 30 per cent of GDP, which is dangerously high.
The debt problems are compounded by other factors. A large portion of the debt is secured over land and property, whose values are dependent on the continued supply of credit and strong economic growth.
A high proportion of debt may be short term, with about 50 per cent of loans being for one year, requiring refinancing at the start of each year. As few Chinese borrowers have sufficient operating cash flow to repay loans, about one-third of new debt is used to repay or extend the maturity of existing debt. With a significant proportion of new debt needed to merely repay existing debt, the amount of borrowing constantly needs to increase to maintain economic growth.
China observers now worry about whether the high absolute levels of debt, rapid increases in borrowing, increasing credit intensity, servicing problems and the quality or value of underlying collateral are likely to result in a financial and economic crisis.