China’s debt levels have been rising rapidly over the past decade, leading many analysts to warn about the risks of a financial crisis. However, assessing whether China is facing a debt crisis depends on understanding the structure and dynamics of China’s debt buildup.
What is the level of debt in China?
China’s total debt has increased dramatically, from approximately $7 trillion in 2008 to over $40 trillion in 2018. Measured as a percentage of GDP, China’s total debt has risen from around 150% of GDP in 2008 to over 260% of GDP in 2018.
Much of this debt is held by state-owned enterprises and local governments. Corporate debt in China stood at approximately 155% of GDP in 2018, with state-owned enterprises accounting for around 100% of GDP. Local government debt was estimated to be about 40% of GDP.
By international standards, these debt levels are very high. Most major economies have total debt levels between 200-300% of GDP.
What is driving the debt buildup?
There are several key factors that have driven the rapid growth in China’s debt:
- Response to the global financial crisis – China engaged in massive credit stimulus to offset the impact of the 2008 global financial crisis. This added nearly $4 trillion in debt over 2009-10.
- Property construction boom – There has been a massive expansion of real estate and infrastructure projects, funded by debt. Much of local government debt is related to infrastructure spending.
- Industrial policy lending – State-owned banks have issued trillions in cheap loans to state-owned enterprises, leading to overcapacity in many sectors.
- Shadow banking growth – The lack of investment options and low deposit rates have driven the rise of unregulated shadow banking. This shadow debt often involves higher risks.
- Trade war and global slowdown – More recently, stimulus lending has increased in response to external shocks like the US-China trade war.
In short, much of China’s debt growth is the result of government-led stimulus initiatives and industrial policies.
Is the debt mostly domestic or foreign?
China’s debt buildup has largely occurred domestically, with the majority of the debt issued in local currency terms. China’s external debt is relatively low, around 12% of GDP, compared to other major economies.
The vast majority of China’s debt is held domestically within the Chinese financial system. As of 2018, only around 10% of China’s total debt was owned by foreign creditors or denominated in foreign currencies.
This contrasts with many emerging markets that have borrowed heavily in foreign currency. This makes China less vulnerable to external debt crises and sudden capital outflows.
Is the banking system healthy?
On the surface, China’s banking system appears reasonably healthy:
- Capital adequacy ratios meet regulatory standards, averaging around 13% in 2018.
- Reported non-performing loan ratios have been low, around 2% of assets.
- Profitability has been quite high, with reported ROE around 13% in recent years.
However, there are reasons to be cautious about these headline numbers:
- Lending standards and risk management are generally considered weak in China’s state-dominated system.
- Political pressures and implicit government guarantees reduce incentives for banks to manage risk.
- The true level of non-performing loans could be higher once unreported bad debts are recognized.
In the event of a sharp slowdown, some analysts estimate that China’s banks could face substantial capital shortfalls. But right now, conditions look stable on the surface.
How sustainable is China’s debt trajectory?
Opinions vary widely on the sustainability of China’s debt buildup:
- Optimists point to China’s strong economic growth, ample fiscal resources, and financial regulations. These factors could allow China to “grow out” of its debt burden.
- Pessimists argue that China’s high and rising debt levels will increasingly weigh on growth. They warn about the risk of a sharper slowdown or financial crisis.
Much depends on whether China can enact reforms to curb excessive credit growth and improve allocative efficiency. Successfully transitioning to a more consumption-driven growth model would also ease debt sustainability concerns.
How concerned are policymakers?
Chinese authorities have become increasingly vocal about risks from excessive debt growth. Some steps taken include:
- Slowing the pace of credit expansion, allowing credit growth to fall behind GDP growth.
- Early interventions and debt restructuring for struggling state-owned enterprises.
- Allowing some bond defaults to impose market discipline.
- New asset management regulations to curb shadow banking risks.
These policies represent a shift towards greater prudence and risk management in China’s financial system. However, political pressures make it difficult to enact aggressive deleveraging policies.
Conclusion: Not a crisis yet, but risks are high
Overall, China is not currently experiencing a debt crisis, but risks are high and rising:
- Total debt levels as a percentage of GDP are very elevated by international standards.
- Dependency on credit for growth creates vulnerability to financial stress.
- Opaque balance sheets and limited market discipline raise the chances of misallocation.
- Slowing nominal growth will challenge sustainability of China’s debt trajectory.
The biggest risk would be a sharp slowdown in China’s economic growth rate. This could rapidly expose debt vulnerabilities in the corporate, banking, and local government sectors.
Downside risks are increasing as China’s economy slows and relations with major trade partners remain uncertain. However, China still has substantial resources and policy tools to stave off a debt crisis, at least in the near-term. The key will be enacting reforms to contain credit expansion and properly allocate capital to productive uses.
There are valid concerns about China’s rising debt levels. But with the banking system still liquid and GDP growth around 6%, China does not yet show imminent signs of a debt crisis. The trajectory is clearly unsustainable, however, and downside risks are rising. Reform progress in coming years will determine whether China can avoid a destabilizing debt blowout.