Despite a significant stock market rally in 2016, investors remain wary of China. A looming debt problem and a slowdown economy are cause for concern, but experts argue that they could be manageable by the country’s government
Chinese debt has risen to 250% of GDP since the global financial crisis in 2008. This level of domestic debt to GDP is considerably higher than other emerging markets’ levels of around 100-150%. The average developed markets’ domestic credit to GDP is at 289%.
That high level of borrowing, together with a slowdown economy, are placing stress on China’s financial system – and raising worries about its impact on the global economy. However, according to Jan Dehn, head of research at emerging markets investment manager Ashmore, concerns regarding Chinese debt are exaggerated.
“China has borrowing levels almost as high as those in developed markets, but there is a very important difference between China and most of the western economies – China has a 49% saving rates,” said Dehn.
“What that means in practice is that every single month when every Chinese worker opens his pay check half of that goes into the bank. And year after year, you end up building up a large amount of domestic deposits in China, of which the stock of domestic deposit to GDP is about 180%.
“Imagine you have a banking system with zero leverage, in other words, the bank only lends out exactly what it has in in the vault. Apply that metric to China it has about 180% deposits to GDP simply by virtual of having a very high saving rate. When you compare 250% domestic debt to a rate of 180% domestic deposits, China is like a very low leveraged bank, while in typical western banks, you put in one deposit and they lend out 10 times that amount.”
Watch Out for Growing Private Debt Levels
However, according to Supriya Menon, senior multi-asset strategist at Pictet Asset Management, it is not the government debt levels investors should be worried about, but the expansion in China’s private sector’s borrowing is particularly worrying.
“China’s private sector debt, known as excess debt, is now equivalent to more than 30% of the country’s output. This amount has proved a reliable predictor of serious financial problems, as evidence shows economies tend to slump once excess debt reaches 10% of its GDP,” said Menon.
China’s excess debt first breached 10% of GDP in the second quarter of 2012. When other countries reached the same threshold, their growth rates tended to collapse, said Menon.
“In China’s case the slowdown has been more controlled. Yet the net effect has been more dramatic. Growth has slowed from an average annual rate of 11% in the years before the critical debt threshold to below 7% now. We estimate that China’ annual pace of real GDP expansion will drop to between 4% and 5% by 2020,” she added.
Can China Manage its Debt Problem?
Looking into China’s December data, new loans and total social financing were much higher than expected, mainly due to higher medium-long term credits to corporates, according to Julius Baer’s economist Susan Joho.
“This likely represents government support in the form of infrastructure and public projects. We expect credit growth to be maintained around current levels in order to support growth, which could soften somewhat due to a property market cooling following restrictions,” said Joho.
Pierre-Yves Bareau, head of emerging market debt at JP Morgan echoes Joho’s views, saying that China’s credit-to-GDP levels will continue to increase until the indebtedness and industrial overcapacity of state-owned enterprises are addressed through the implementation of structural reforms.
But Pictet’s Menon believed that China could manage the country’s corporate debt problem.
“Chinese corporate default rates are a mere 0.3% currently. Generally, economies can handle rates of around 2% without significant spill-overs,” said Menon.
Menon added that while two thirds of outstanding corporate debt is held by state-owned enterprises, it would be a natural solution for the Chinese government to make good on these firms’ bad debts.
While Menon does not expect China to trigger the sort of global catastrophe that followed the Lehman Brothers bankruptcy, Menon warned that even if Chinese government correctly diagnoses the problem in years, there is no guarantee it will avoid missteps.
