Some prominent investors are worried about China’s debt. George Soros sees an “eerie resemblance” between conditions in China now and those in the US leading up to the financial crisis in 2008.
“It’s similarly fueled by credit growth and an eventually unsustainable extension of credit,” Soros told the Asia Society in New York in April.
BlackRock chief executive officer Laurence Fink was asked about China’s mounting debt on Bloomberg TV in May.
“We all have to be worried about it,” Fink said, adding that he remains bullish on China’s economy in the long term.
And in June a Goldman Sachs report said that the country’s large and unaccounted-for shadow-banking activities raised concern “about China’s underlying credit problems and sustainability risk.”
RAPID GROWTH
Despite that rapid growth, household debt in China is far below levels in the US before the subprime crisis. At its 2007 peak in the US, household debt reached almost 100 percent of GDP. What is more, in China household savings are twice as large as debt. Deposits were about 55 trillion yuan (US$8.2 trillion) at the end of last year, while debt was 27.4 trillion yuan.
Another big difference between China today and the US during the subprime bubble is that Chinese residential properties are typically purchased with significant down payments.
According to the China Household Finance Survey, the average household debt in urban areas amounted to only 11 percent of home value in 2012. Mortgage debt remains comparatively rare.
That showed up in the survey data: The median household debt was 0 percent. The same survey also found that if housing prices were to decline 50 percent, less than 14 percent of mortgages would exceed the value of the properties. Given China’s high savings rate and low leverage, it seems unlikely that households would cause a financial crisis.
If overwhelming debt does trigger a crisis in China, it is more likely the spark would come from corporations and their main creditors, the banks. China’s bond market has shown signs of growing stress, including 17 defaults through June 30, almost triple the number last year. That and a series of delayed payments prompted rising credit spreads and cancelations of new issues.
Leverage problems are not evenly spread across Chinese corporate sectors. Energy and materials companies have the lowest ability to service debt. Among Chinese energy companies last year, the median earnings before interest and taxes (EBIT) was less than one times total interest expense, according to Bloomberg Intelligence.
At materials companies, the median EBIT was twice the interest expense. By contrast, Chinese healthcare companies have median earnings of more than nine times interest expense.
Information technology and telecommunications services companies generate earnings that are more than five times interest expenses.
While certain industries and enterprises have a lot of debt, Chinese companies’ average leverage is not high, according to a recent IMF working paper.
Since 2006, listed companies that are not state-owned have reduced median liabilities to 55 percent of common equity.
However, at state-owned enterprises median leverage has been unchanged at about 110 percent. Leverage has increased at the tail end of the distribution, driven by rising debt at companies in construction, mining, real estate and utilities.
An increasing share of debt is attributed to a few companies with high leverage ratios.
China is different from other markets in an important way. Many large corporations and nearly all the major banks are state-owned. In other words, the debtors and creditors are ultimately owned by the same entity.
That means the country could address debt problems in some unusual ways. One scenario is the state could take from the prosperous — coastal regions or high tech, for example — and give to the struggling.
Another is that the government could simply cover debt. Some unprofitable state-owned enterprises are supported by lending from their banks essentially to keep employment at acceptable levels. Such debts could eventually be absorbed by the state as part of its social welfare expenditures.
OPENING UP
As China gradually opens up its stock and bond markets, more capital could become available to deal with the country’s obligations. The potential inclusion of Chinese stocks and bonds in the global indices over the next few years would help facilitate that.
This is not to say that China does not have some serious problems.
Growth is slowing and the economy needs major restructuring. There will be winners and losers and turmoil in the market. Shadow-banking activities add another risk.
It is not certain that the government will handle the challenges in the next decade as deftly as it has in the past. The country’s economy is far larger and more complex.
Fortunately for the rest of the world, China has a high savings rate. Capital controls are not fully lifted, making capital flight difficult. The government has almost complete control of the banking industry.
In addition, China’s listed banks get about 70 percent of their funds from deposits. In comparison, US investment banks in 2008 relied heavily on short-term money-market funding.
Such circumstances make it unlikely that China’s debt will spark a global crisis in the near future.
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