China’s Debt Bomb
Danger or Dud?
It’s a bomb! A mountain! A horror movie and a treadmill to hell! To doomsayers, China's $26 trillion pile of public and private debt is a threat to the global economy. Or maybe it's just a manageable byproduct of the boom that created the world’s second-biggest economy. Either way, the buildup has been breathtaking, with borrowing quadrupling in seven years by one estimate. (China doesn't give a complete tally). Weaning the nation off that debt without intensifying an economic slowdown is tricky. Because China is a key driver of global growth, the solution is everybody's concern. Propping up borrowers to prevent defaults is one approach. That could leave the country mired in bad debt and susceptible to years of stagnation.
China's total borrowing soared to an estimated 247 percent of GDP at the end of 2015 from 164 percent in 2008. That’s faster than the increase in the U.S. and U.K. in the run-up to the 2008 financial crisis. The problem could be bigger still because the frantic pace of new lending makes it hard to know how many loans aren't being repaid. Regulatory loopholes, banks' off-balance-sheet portfolios of wealth management products (likened by some to Western lenders' exposures in the subprime crisis), and widespread shadow banking practices further complicate the picture — as does a system of implicit guarantees that obscures how much of the debt is backed by the government or who would be allowed to go bust. Local and provincial governments have borrowed about $4 trillion—the size of Germany's economy—and some used shorter-term, off-balance-sheet borrowing to fund dubious infrastructure and real estate projects. Chinese authorities are gradually allowing more defaults, which is driving up financing costs for companies. Banks have begun exchanging high-interest loans to local governments for low-cost bonds in a state-backed swap program that may expand to 15 trillion yuan ($2.3 trillion). The debt splurge continues: Borrowing by 29 of China's 31 provinces skyrocketed 53 percent in just two years through the end of 2015. And $1 trillion of new credit was granted in the first three months of 2016, much of it flowing into a resurgent property market. But there are signs the government may no longer tolerate spiraling debt: A prominent Communist Party newspaper declared in May that high leverage was China’s “original sin” and the country could not borrow its way to long-term economic health.
During the 2008 financial crisis, Beijing ordered local governments to build roads, bridges and other public works to keep the economy pumping and workers in jobs. It set off a borrowing binge that's invited comparisons with Japan's debt bubble of the 1980s that ended in a property and stock market crash that left zombie banks saddled with bad debt. China has seen busts before. In the late 1990s, at least a quarter of the nation’s credit soured after years of state-directed lending, triggering a $650 billion bailout of state banks. The latest buildup comes amid China's slowest economic growth in 25 years and President Xi Jinping's push to shift the economy toward consumption and away from debt-intensive heavy industry and exports. The central government retains controls over banks, foreign exchange and capital flows, so it can manipulate the financial system to contain the debt burden and limit the risk of a blowup. There's an assumption that it will funnel money into the economy to prevent a wave of defaults, as it has propped up China's stock market. At the same time, officials are keen to introduce more free-market discipline, which could increase their tolerance for bankruptcies.
Optimists say concerns about China's debt are overblown; companies and local governments can simply grow their way out of the problem as an expanding economy supports borrowers and creates inflation, which erodes the burden of debt repayments. China's high savings rate and its current-account surplus help, too. Pessimists say the problem is not self-correcting. They expect policy makers to tackle nonperforming loans and stave off defaults. Options include cutting interest rates, expanding debt swaps, clamping down on nonbank lending, pushing for asset sales and encouraging more companies to raise money through stock sales. Charlene Chu, the former Fitch Ratings analyst known for her warnings about China’s debt, says that the dangers are increasing and that a bailout of trillions of dollars is needed. There's a risk that China's debt could remain a drag on global growth for decades.
The Reference Shelf
- McKinsey examined the size and complexity of China’s debt in a February, 2015 report.
- The International Center for Monetary and Banking Studies researched the expansion of global debt.
- Bloomberg QuickTakes on shadow banking, China’s managed markets, and the yuan.
- Bloomberg Intelligence's blog examined the buildup of local government debt.
- Charlene Chu, a banking analyst who made her name warning of the risks from China’s credit binge, details the case for a “massive bailout.”
First published June 18, 2015
To contact the writer of this QuickTake:
Enda Curran in Hong Kong at firstname.lastname@example.org
To contact the editor responsible for this QuickTake:
Grant Clark at email@example.com