Key Takeaways

· China’s recovery from the global economic crisis of 2008 was built on significant and unsustainable debt levels.

· Total Chinese debt is believed to be $30 trillion, with consensus building that something must be done.

· Despite its debt problems, China still has resources available to combat the problem.

China’s increasing debt may be approaching the tipping point. China’s economic growth has been driven largely by capital investments—buildings, roads, factories, even entire cities—since the 1990s. In the process, Chinese regional governments, banks, and companies built up large debts. As the global economy slowed, Chinese leaders have increased infrastructure investments to maintain employment and “social harmony.” However, these investment programs have added to the debt problems. Increasingly, the conversation about Chinese debt, both internally and externally, is about the economic risks it has created. Although unlike other highly indebted nations, China has options. Most of its debt is owed internally; it controls its own destiny, unlike Greece or Argentina. It also has high levels of foreign currency reserves and domestic savings.

China’s debt: how much is too much?

The absolute number is scary. Chinese entities—its government, companies, and households—now owe approximately $30 trillion. We, along with most market participants, believe the best way to evaluate a nation’s debt load is by looking at debt relative to gross domestic product (GDP) [Figure 1]. After all, a nation’s GDP will provide the wherewithal to repay that debt. From 2004 to 2008, overall Chinese debt was fairly stable at just over 150% of GDP. The government responded to the financial crisis in 2008 by creating a $600 billion fiscal stimulus program, over 13% of GDP at the time. Much of this stimulus was debt fueled and put in place by encouraging corporate borrowing. Some of this borrowing resulted from traditional monetary policies like lowering interest rates and amending rules to make credit more accessible. But much of stimulus came from the government’s control of the economy through its state-owned enterprises (SOE), the major companies that at the time comprised 40% of the economy. Although the state sector has shrunk in relative terms since then, it still represents over 30% of the Chinese economy.


Evaluating China’s Data

As a general rule, evaluating Chinese data can be challenging due to heavy government intervention in the economy. The distinction between the private and public sectors in China can be blurry, if not totally illusory. Yet, when evaluating the China’s debt, these distinctions become much less important. The default of a major SOE will reflect just as negatively on the government had it been a technical government default.

Though China’s debt has been worrisome for some time, the concern has been growing recently. Figure 2 shows two ways to gauge market fears of defaults in China. Credit default swaps (CDS) on Chinese debt provide a direct window into major market participants’ views on Chinese debt. CDS represent the costs of insuring against a Chinese default. Major global financial investors and institutions trade these contracts. Though the cost of insuring Chinese debt can be volatile and is off its recent highs, the overall upward trend in price shows the market’s increasing concern. The fact that there are even traded contracts like this is evidence the market is looking to price some probability of default. We also show the decline in the value of the Chinese yuan against the currency of China’s major trading partners, not just the U.S. dollar. Many factors influence a currency’s value. However, fears of economic instability and possible default have contributed to recent currency weakness.

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