It’s a bomb! A mountain! A horror movie and a treadmill to hell! To doomsayers, China's $27 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. Cleaning up the nation's banks is one approach. Propping up borrowers to prevent defaults is another. The latter could leave the country mired in bad debt and susceptible to years of stagnation.
China's borrowings soared to about 264 percent of GDP in 2016 from 163 percent in 2008, outpacing the surge in the U.S. and U.K. before the financial crisis. 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 real estate or infrastructure projects. The problem could be bigger still because of the frantic rate of new lending, which makes it hard to know how many loans aren't being repaid. The picture is complicated by shadow banking practices, including banks' wealth management products — likened by some to Western lenders' exposures in the subprime crisis. Chinese authorities are gradually allowing more defaults, while banks have begun exchanging high-interest loans to local governments for low-cost bonds in a state-backed program that may expand to 15 trillion yuan ($2.2 trillion). Lenders have been busy swapping debt for equity, but are feeling the strain: one indicator of banking stress surged to a record last year amid warnings of the need to raise fresh capital. A Communist Party newspaper declared in 2016 that high leverage was China’s “original sin” and the country could not borrow its way to long-term economic health. Yet the splurge continues: outstanding credit is expanding at more than 15 percent per year, way above the growth in GDP. And in May, Moody’s Investors Service cut its rating on China’s debt for the first time since 1989, challenging the view that the nation’s leadership will be able to rein in leverage while maintaining the pace of economic growth.
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 which 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, an 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
- A Bloomberg infographic digs into the growing pile that is China's debt.
- An IMF report on China's debt from 2016.
- McKinsey examined the size and complexity of China’s debt in a 2015 report.
- The International Center for Monetary and Banking Studies researched the expansion of global debt.
- QuickTake Q&As on wealth management products and another potential problem called entrusted bonds.
- Bloomberg QuickTakes on shadow banking, China’s managed markets, and the yuan.
- Bloomberg Intelligence's blog examined the buildup of local government debt and the overall debt problem.
- 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
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