China Bad Debt Could Spark Global Growth Slump

Photograph by Jerome Favre/Bloomberg

Just how high have China’s bad-loan levels gotten? Amid a massive, five-year expansion in credit, and with the recent economic slowdown, the answer is becoming ever more important.

One reason people are wondering at all is that official figures look too low to be credible. Even as China’s debt level has soared, with the ratio of private-sector credit to GDP rising from 104 percent in 2008 to 134 percent by 2012, China’s reported nonperforming-loan ratio is only 1 percent—and that figure has changed little over the past few years.

The real situation is probably far scarier, says a new report released May 8 by consultancy Oxford Economics. More likely, China’s bad-debt ratio is somewhere between 10 percent and 20 percent, amounting to 6 million to 12 trillion yuan ($1 trillion to $1.9 trillion), says senior economist Adam Slater in “China: How bad could bad loans get?”

“The estimated range is wide, reflecting considerable uncertainties,” writes Slater. “But even at the lower end of the range, the absolute size of NPLs would be very large—while the upper end of this range would suggest a bad asset problem comparable in scale to that seen in the wake of the U.S. subprime crisis.”

Slater comes up with his somewhat alarming estimate by looking at China’s own experience with a rapid runup in bad debt in the late 1990s, as well as by comparing it with ratios in other countries. For example, while China saw its credit-to-GDP ratio rise 27 percentage points from 1995 to 1999, its NPL ratio went up 13 percentage points over the same period. And by the early 2000s, the bad-debt ratio reached a high of almost 30 percent.

Meanwhile, China has experienced an even higher expansion of borrowing as a proportion of its total economy in recent years. “The fact that the reported NPL ratio has failed to increase in the wake of the credit expansion of 2009-13 is hard to understand given the experience of the 1990s,” he writes.

Slater also looks at a group of 33 countries that went through periods of credit booms followed by financial crises in the period from 1980 to 2008. Most of them saw nonperforming loans peak at levels far higher than China’s official levels now. Finland in the early 1990s and Greece in 2008, for example, had debt ratios around 15 percent, while Thailand and Malaysia reached levels twice that in the late 1990s. “Once again, this analysis suggests that China’s currently reported NPL ratio is abnormally low,” writes Slater.

If indeed China’s bad-debt ratio is now in the 10 percent to 20 percent range, that has alarming ramifications: “NPLs on such a scale could be the trigger for a serious banking crisis in China, with major regional and global economic implications.” That, in turn, could produce a “Chinese GDP growth slump below 2% and world growth … as low as 1%,” he writes.

Before it's here, it's on the Bloomberg Terminal.