China could struggle to repay an ever-increasing wall of debt with potential detrimental consequences for the global market. (ABC News: Jarrod Fankhauser)
While many countries struggled following the 2008 global financial crisis, China appeared as though it had largely escaped unscathed.
- China’s rising levels of debt mostly attributed to a “credit boom” post GFC
- Many large infrastructures are struggling to generate positive revenue
- Chinese local government debt has been called an “iceberg” with “titanic risks”
But observers are becoming increasingly concerned Beijing will struggle to repay an ever-increasing mountain of debt, with potential detrimental consequences for the global market.
China’s debt has been a key factor to its economic success in riding out the GFC, due to a large government stimulus injected into its economy.
However, the financial boost has mostly led to China having one of the highest corporate debts in the world, only second to the Special Administrative Region of Hong Kong.
The past year has been a tumultuous one for the Chinese market: it was hit by an economic downturn, and for the first time in two years, exports unexpectedly plunged to its lowest point, all of this against the backdrop of an ongoing trade dispute and punishing tariffs by the US.
Beijing made moves to solve its issues by slashing central bank reserves earlier this month — the fifth time within a year — freeing up $US116 billion ($161.3 billion) to stimulate more economic growth.
But forecasted figures by a number of global financial institutions are not looking too positive for the global superpower, and adding to the debt fears is an opaqueness and inability for analysts to completely obtain information and understand the full extent or impact of the potential looming problem.
‘There’s no positive way to spin it’
The Tianducheng development in Hangzhou was designed to accommodate 10,000 people, but remains sparsely populated. (Reuters: Aly Song)
A common misconception about the Chinese economy is that it is largely driven by exports, and while that might be the case prior to 2008, it all changed during the crisis when global demand for Chinese imports quickly declined throughout Europe and the United States.
To ride out the GFC, the Chinese Government injected a $US4 trillion ($5.5 trillion) stimulus to create jobs through large-scale infrastructures projects, real estate and foreign investments — despite limited domestic market interest.
According to the Bank for International Settlement (BIS), China’s overall debt currently sits at 255.7 per cent of its gross domestic product (GDP), with its corporate debt standing at 160.3 per cent, well ahead of Japan and the US.
However, the concerns do not surround the amount of China’s accumulated debt, but rather the rate of its corporate debt and its growth since the GFC, which also includes State-Owned Enterprises (SOE) and local governments, prompting fears of a financial crisis with a domino effect.
Corporate debt is the amount of money borrowed by non-financial institutions from the private sector, while accumulated debt also includes household and public debts.
While many economists do not seem particularly concerned about a debt default due to China’s large foreign reserves, including $US1.15 trillion in US bonds, speculation of a credit crisis still ranges from an economic slowdown to the next global financial crisis.
While its still up for debate, many agree the effects could be felt across the globe.
‘A debt iceberg with titanic credit risks’
According to the World Bank and the IMF, the Chinese economy is forecast to continue to slow down in the coming years. (Reuters: Stringer)
Jane Golley, an economist and acting director at the Australian Centre on China in the World at the Australian National University, said the issue had become more complex as it was not known how big the debt was and how it was being spent.
“The uncertainty it creates makes global capital markets, individual investors and even local domestic consumers nervous about that trickle-down effect,” she told the ABC.
Dr Golley added that China could not sell all its US Government bonds as it would have “major global implications”.
A report published by S&P Global Ratings in late 2018 found off-balance-sheet borrowing by local governments as high as 40 trillion yuan ($8.2 trillion) and dubbed it “a debt iceberg with titanic credit risks”.
James Laurenceson, deputy director at the Australia-China Relations Institute at UTS, said the debt held by the corporate sector, particularly in SEOs, became a core part of the problem, especially through “zombie firms” which do not generate revenue.
“There’s no positive way to spin it … debt has been ploughed into assets that aren’t producing a substantial return,” he said.
“This is slowly grinding down China’s growth rate and means more policy stimulus is needed to produce the same amount of growth.”
‘A total waste of money’
China’s central bank slashes capital requirements for the fifth time in a year amid an economic slowdown. (Reuters: Reinhard Krause)
According to the China Power Project at US think tank the Center for Strategic and International Studies, state-owned enterprises accounted for more than half of China’s corporate debt in 2016, while only accounting for half of its GDP.
He-Ling Shi, an economist from Monash University, said some of these infrastructure projects were “a total waste of money and will not generate cash flow”.
He was referring to empty “ghost cities” and an array of abandoned projects such as airports and large buildings with limited use.
“Some cities with fewer than 100,000 in population have applied to build subways where the roads above are totally empty,” he said.
“Also some airports constructed using loans from banks which provide services for very limited numbers per year,” he said.
China’s potential crisis may also be lurking in its “shadow banking” system which has been tied to its “credit boom”.
Shadow banking is an unregulated and unstable aspect of the Chinese market which sells anything from wealth-management products to investment trusts — creating a notion of an expanding economy beyond official channels.
According to Dr Shi, shadow banks have been used by local governments to finance infrastructure projects, therefore contributing to the overall government debt.
A report published by BIS last year found much of the sector was driven by traditional and state-owned banks with significant levels of state involvement.
‘Bad outcome’ imminent; sense of crisis ‘contagious’
A 2016 International Monetary Fund (IMF) report found 38 out of 43 economies whose national debt was 30 per cent higher than its GDP experienced “severe disruption” in the form of financial crises and a decline in growth.
It also found the probability of a “bad outcome” was imminent if the boom lasted for more than six years — these are all criteria the Chinese economy meets.
Dr Laurenceson said it was unlikely a Chinese financial crisis would lead to a catastrophic, US-style market collapse and cause the next global financial crisis.
“This means that rather than a collapse, if the root causes aren’t addressed, China’s growth rate will just slowly grind down for the foreseeable future,” he said.
He added that even this would be problematic as it had the potential to result in an economic stagnation similar to Japan’s “lost decade” following the collapse of its asset prices.
The Government seems to have recently introduced a number of financial reforms and budget restructuring aimed at lowering debt levels. (Reuters: China Daily)
According to the World Bank and the IMF, the Chinese economy is forecast to continue to slow down in the coming years, further adding to the anxiety around whether Beijing can repay its debts.
Dr Shi said it would continue to be an ongoing and difficult issue, with no clear solutions.
“If the Chinese GDP can be maintained at 6 per cent per year, in theory, it can still use its economic growth to repay its debt, however, this is a little bit too optimistic,” he said.
He added that some of the infrastructure projects would need positive cash flow which then could be used to pay back some debt, but, “It might take a very long time”.
“When it becomes massive is when that sense of crisis becomes contagious,” Dr Golley said.
“Its not just a debt crisis on its own but it’s the fear of debt crisis reducing consumer confidence, business confidence even further and then having impacts on Chinese demands for imports … and it all starts to ratchet up through there.”
The Chinese Government seems to have recently introduced a number of financial reforms and budget restructuring aimed at lowering debt levels in recent times, including greater restrictions on debt-financed overseas investments, allowing some state-owned zombie firms to go insolvent, and a reduction in coal and steel industries.
But Dr Laurenceson explained there was only limited evidence the authorities were addressing the root causes of the problem.
He said there had been attempts to audit books of local governments to move lending from murky, high-interest-rate shadow banking to official banking sectors, however, it still did not balance the disproportionate quantities of state-owned firms which were far less productive than private companies.
The Chinese Government considers SOEs to play an important stabilising role in society, and Dr Laurenceson added Beijing would be “reluctant to let them go bankrupt and close” therefore contributing to the “potential risk to growth and financial stability” of the second-largest economy in the world.