Chinese authorities need to tackle their domestic debt crisis or risk ending up with years of stagnation akin to Japan’s, threatening the growth China has achieved and impacting economies reliant on the country, industry experts have said.
China’s public debt totalled 97% of GDP in the first quarter of 2023, according to a May report from Natixis CIB. That includes local government financing vehicles (LGFVs) that local governments used to raise off-balance sheet debt for infrastructure and real estate projects.
While this is still less debt than the US — whose ratio was 120% at the end of 2022 — China’s actual levels are significantly higher. State-owned companies have substantial debts and there is limited information on LGFVs.
Total debt in China’s household, corporate and government sectors reached 282% of GDP in the second quarter this year, according to Bloomberg data.
That spike, including at the corporate level, came with a crisis in China’s property sector. Marquee developers like China Evergrande Group defaulted and Country Garden remains on the edge of a possible default.
Aidan Yao, a senior China economist formerly at Axa Investment Managers, said 2016 was a critical year. China unveiled its debt-to-equity swap programme as part of a deleveraging campaign. But the opposite happened: investors were led to view implicit government guarantees for local authority debt as explicit guarantees, giving them confidence and tempting governments to issue more.
“People pay a lot of attention to China debt because of the speed of the accumulation,” Yao said. “But it’s also because of the mismatch in their debt.”
Local governments tend to borrow short but lend long, particularly to infrastructure projects that take years to generate returns.
China’s precarious debt and economic situation is now triggering comparisons with Japan, whose property and stock markets burst in 1992 following years of euphoria.
Over the next decade, Japan’s authorities laboriously cleaned up the ‘three excesses’ — debt, production capacity and employment — leading to big capital losses for companies and banks and pressure on growth.
Shigeto Nagai, head of Japan economics at Oxford Economics, said that while he did not expect a Japanese-style debt recession in China over the coming years, he was concerned about China’s way of tackling its debt situation.
“Its approach is to avoid drastic balance sheet clean-up and clean-up of non-performing loans behind this property bubble,” said Nagai. “Their reluctance to take decisive steps could end up with prolonged stagnation in the coming period, and this could gradually hurt the health of the banking sector and deteriorate banks’ ability to provide credit for growth.”
Gary Ng, a senior economist at Natixis CIB in Hong Kong, said the market should be worried about contagion from China’s real estate debt crisis to other industries, like the banks, or defaults on government, quasi-sovereign or government-backed bonds. Ng said: “This will have an implication for not only growth, but also capital flows and financial stability.”