China’s debt crisis – is it a problem or not?

China’s economy has been growing strongly for years, but debt has also been piling up as a result. The country has recently taken steps to reduce the debt burden on companies, but now consumer debt is growing fast. Is this a threat to the world economy and financial markets or not?

In August 2017, the International Monetary Fund (IMF), the world’s financial watchdog, sounded a warning about the debt situation in China. Unless the country can bring its continual increases in private and public debt under control, its future growth prospects are under threat. The IMF went as far as to call the situation “dangerous”.

Why is that an issue outside China? Well China’s trade in goods and services, and demand for commodities, is now a key driver of the global economy. If China collapses under the weight of debt, then the impact will be felt across the world.

Marc Ostwald of ADM Investments explains why he doesn’t think there’s a debt crisis

 

The Chinese economy has been growing rapidly for years, but that was largely driven by China’s banks and the state extending credit to companies. The lending exploded in the wake of the financial crisis as China sought to negate the impact of falling exports by stimulating infrastructure spending. More recently, the government has been trying to rebalance the economy so that it’s less reliant on manufacturing , while consumer spending is a more important factor. But that has led to a boom in consumer debt as banks have lent money to fuel the spending.

China’s debt pile is growing very rapidly

China’s debt mountain currently stands at about 256% of GDP. That’s actually much less than Japan, where the debt-to-GDP ratio stands at 373%, and about level with the US. However, it’s the rapid growth of the debt that is worrying experts – the sort of pace which can rapidly turn boom to bust. According to the IMF, China’s non-financial sector debt could reach nearly 300% of GDP by 2022. And when government debt is excluded, the rate of growth in corporate and household debt has been even more rapid.

In fact, every facet of China’s economy is affected. The state, commercial banks, state and private companies, and now consumers, have high, and growing, debt levels. Analysts at Deutsche Bank recently warned that China’s banks have never really experienced a consumer credit cycle, and so it remains to be seen how they handle a rise in bad loans – borrowing what consumers can’t repay.

Does this mean a debt crisis is just around the corner? Possibly not. Why? Because China’s government is determined it won’t happen, maintaining a policy of growth at all costs. The government and the People’s Bank of China orders the state-owned banks to lend to state-owned companies, many of them so-called zombie companies that don’t actually do anything, so those companies can refinance debts they are struggling with. That means the smaller banks who own the loans can keep on lending, and so the money flow continues.

Experts have been warning for years that China’s growing debt pile was a crisis to come that would reverberate around the world. It still hasn’t happened.

China’s government controls the money supply

Because China’s government is controlling the money taps, it is giving itself the time to sort out the mess, goes one argument as to why this isn’t a crisis. Another argument is that the debt is all contained within China, and so while there will be an economic impact from a Chinese credit crisis, it’s unlikely to result in a new global financial crisis.

But can China’s government solve the issue at the same time as sticking with its ambitious economic growth targets? It has taken some steps to try and deal with the debt problem. It has announced plans to ease the corporate debt burden through a series of so-called debt-for-equity swaps - essentially turning the debt into shares and pushing the risk onto shareholders rather than the debt holders – but these had limited impact and didn’t stop the overall debt burden from increasing.

Impending crisis or not, the debt mountain is real and China’s government is going to have to do something about the steep growth in indebtedness. It’s one to watch.

 

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