China’s Debt Pile Raises Concern

Karen LiuFeb 23,2018,15:27

According to the latest data published by the Bank for International Settlements (BIS), by the middle of 2017, China's debt-to-GDP ratio reached 256%, contrast with 190% on average in emerging countries and 250% in the United States. In addition to the high debt levels, the speed of China's debt build-up is also causing alarm. The last five years saw two-digit annual debt growth. Based on this, the IMF anticipates that by 2020 China's debt to GDP ratio will rise to 300%. The higher the debt-to-GDP ratio, the less likely the country will pay back its debt and the higher its risk of default. In September 2017, S&P Global Ratings cut China's sovereign credit rating for the first time since 1999, following a rating downgrade by Moody's in May, both on warnings of China's growing debt.

What's the driver of China's debt pile?

The overall debt in real economy can be disentangled into government debt, households debt and non-financial corporations debt.  The following cross-country comparison finds in 2017 China's leverage ratios in households and government sectors were 47% and 46%, respectively, much lower than the United States' counterparts. However, the leverage ratio of non-financial corporations in China was 163%, overwhelmingly higher than that in emerging countries and in the United States as well. Obviously, the problem of China's growing debt lies in the non-financial corporations sector. 


Source: Bank for International Settlements (BIS)

Do we catch the point?

Yes. According to a number of studies on the debt crisis, the rapid growth of non-financial corporations debt is a signal of a looming economic crisis. The debt problem in this sector should be taken more seriously. Ruchir Sharma, head of emerging markets and chief global strategist at Morgan Stanley Investment Management company, analyzes the economic data from 1600 to the present and finds that if the debt-to-GDP ratio in a country's private non-financial sector (i.e., non-financial corporations sector plus households sector) rose more than 40% in the past five years, then there will be a great possibility of being caught into a crisis in the next five years. As far as level is concerned, the warning ratio is around 200%. History confirms this assertion. Japan ran into Heisei recession when it private non-financial sector debt-to-GDP ratio exceeded 200% in 1990. The United States undergone a subprime crisis when the ratio reached 170% in 2008. Meanwhile, Spain's property bubble burst when the ratio was over 200%. Now, the private non-financial leverage ratio in China has risen 90 percent since 2009 and has hit 210%. 

Another indicator of crisis is the Debt-to-GDP Gap of private non-financial sector, which is the deviation from the historical trend line. 10 percent of deviation is generally considered as the breakthrough point. Historically, Japan, Spain, and the United States, without exception, had severe financial crisis and economic recession when the gap reached 24%, 44%, and 12%. Now, the Debt-to-GDP Gap of private non-financial sector in China is around 20%. 

Those indicators suggest that many countries who have undergone China's current experience of high credit growth in private non-financial sector eventually experienced painful economic crises or economic downturns. Then is an economic crisis is approaching in China?

The answer is not yet. There are still many positive signals to ease the market's fear. First of all, it is important to distinguish between external and internal debt. 95% of China's debt is domestic debt. So the debt could be backed by high household and corporate savings. At present, the China has the world's leading saving rate, around 30%.  As long as the savings continue to finance the existing debt, the debt problem is hard to evolve into a systematic crisis. Moreover, with respect to the large non-financial corporations debt,  since two-thirds of it is owned by Chinese state-owned enterprises (SOEs), it is probable that the government will bail enterprises out with soft policy loans before any contagion hits the banks.

Importantly, China still has a large bulwark of foreign exchange reserves and precious metals such as gold reserves serving as a buffer to external sovereign volatility. During the period 2000-2015, the Chinese government has considerably increase its reserves up from 16.5 trillion yuan to 102.9 trillion yuan. That means, for now, the government still has a strong capacity to deal with debt risk. In addition, the central bank of China is in control of sovereign monetary policy and its exchange rate. This means China's circumstances are better off than both Greece who had no monetary policy control, and the United States who had no exchange rate control.

Although there is much to indicate that China is far away from a looming financial crisis, it has to be admitted that deleveraging is inevitable, especially in the non-financial corporations sector.  As the National Development and Reform Commission said in a statement, China will focus on lowering leverage ratios among state-owned firms and winding down of“zombie firms”to reduce leverage ratios and control debt risks.  Some policies on de-leveraging non-financial corporate debt have been adopted, including swapping SOE debt for equity and providing policy loans to encourage SOEs to merge and streamline.  This point to a future corporate structure more likely to withstand domestic debt pressures.


[1] The corresponding term of debt-to-GDP ratio in BIS Statistics is total credit to the non-financial sector as a percentage of GDP.

[2] The corresponding terms of government debt, households debt and non-financial corporations debt in BIS Statistics are total credit to the government sector, total credit to households and total credit to non-financial corporations, respectively. 

Topics:China’s Debt Pile