21 July 2018
A relatively closed capital account and local-currency-denominated borrowing make China's debt problem manageable. Photo: Bloomberg
A relatively closed capital account and local-currency-denominated borrowing make China's debt problem manageable. Photo: Bloomberg

Does China have a ‘debt bomb’?

Conventional wisdom has it that China has built up an excessive amount of debt that would crush its economy sooner or later.

The following debt data has often been cited as a warning of the nation’s “debt bomb”: Total domestic credit amounts to 250 percent of GDP (or 159 trillion yuan as of 2014); corporate debt amounts to 124 percent of GDP (or 79 trillion yuan), of which 5.6 trillion yuan is in US dollars (or US$907 billion); and local government debt amounts to 32 percent of GDP (or 17.9 trillion yuan).

Also, total claims by international banks on China amount to US$1.1 trillion, according to the Bank for International Settlements.

In absolute terms, these numbers look alarming, hence the pessimism over China’s growth. But they are meaningless when assessed in isolation, as the market often does. How do we know whether China has too much debt? And why has such a debt burden emerged when the national savings rate is among the highest in the world?

Let us put China’s debt into perspective. The country’s total (corporate plus government) debt, at 192 percent in 2013, is less than the world average of 204 percent of GDP. It ranks in the middle of the world debtors’ league.

China’s public (local and central government) debt amounts to 52 percent of GDP, and is below the 60 percent dangerous threshold deemed to be the international norm. Meanwhile, global average is even higher at 71 percent of GDP, due to big debtors like Japan, the US, the UK and other European countries like Portugal, Spain, Italy.

China’s corporate debt is also less than the global average of 133 percent of GDP, though it is higher than the level at some of its Asian peers.

Why has China built up debt, despite its high (50 percent-plus) national saving rate? The answer lies, ironically, in the nation’s high savings. Debt arises when an economy transforms its savings into investments; so the more the country invests, the bigger the debt it builds. There are two ways to intermediate the transition, either through equity or debt financing.

If all national savings are transformed into investments via the equity market, the economy incurs no debt. In reality, there is always a portion of national savings that is transformed into investments via the debt market (including bank borrowing and bond issuance).

In a closed system, given a stable structure of financial intermediation between equity and debt financing, the higher the national savings, the higher the debt level. So there is nothing wrong with debt; it simply mirrors cumulative savings.

However, debt plays a different role in an open system where a country can borrow from abroad. In this case, a nation builds up net foreign liabilities. However, it may lend its excess savings to foreign borrowers and build up net foreign assets.

It is crucial to note that while a low-saving country can accumulate a large debt via foreign borrowing, a high-saving country, like China, almost always runs a high level of debt due to financial intermediation that transforms savings into investments.

Both Anglo-Saxon countries and Asian economies have built up debt steadily over the decades, but they have totally different net-debt positions. The former has accumulated large net foreign liabilities due to insufficient savings, while the latter has built up large net foreign asset holdings due to a surplus of savings.

It is sometimes possible that debt built on borrowed savings could be more susceptible to financial instability than that built on domestic savings. China’s debt belongs to the latter category. Take, for example, the US$907 billion Chinese company foreign liabilities, or the US$1.1 trillion foreign-bank claims on China, that the market is worried about – they account for no more than 4.2 percent of China’s total debt.

This means that China’s debt mirrors its large domestic savings and is basically denominated in domestic currency. No country has run into a currency crisis when its debt is denominated in domestic currency (e.g. Japan and the US). A financial crisis may occur, but it would be a domestic problem that can be resolved by reallocating domestic savings (as is China’s case).

This suggests that China’s debt build-up is mostly a result of its industrialization, but not excessive consumption, funded by high national savings. It remains a net creditor to the world, as witnessed by its current account surplus. The debt load and servicing needs are still manageable.

A relatively closed capital account and local-currency-denominated borrowing make China’s debt problem manageable. However, this could change if Beijing cannot manage prudently the tendency in recent years for debt to accumulate and for the share of foreign liabilities to rise, while the capital account is opening up gradually.

Opinions expressed here are the author’s and do not necessarily reflect those of BNPP IP.

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China’s debt level is below global average. Chart: World Bank, BNPP IP (Asia)

Senior economist of BNP Paribas Investment Partners (Asia) Ltd. and author of “China’s Impossible Trinity – The Structural Challenges to the Chinese Dream”

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