China's Debt Mountain is Piling Higher

A Tale of Debt-Driven Growth

Overview:

On Wed 28^th, 2017, China’s debt surpassed 300% of GDP. Though this figure remains lower than Japan’s, some analysts are concerned that the increase in debt could lead to a potential financial crisis.

(MarFarlane, 2017)

Growing Concerns:

Chinese corporations currently operate with a high amount of leverage, which is the core of the country’s debt problems. In total, 67% of the national debt is owned by publicly traded companies and more importantly, about two-thirds of corporate debt is owned by state-owned enterprises, many of which are, on the surface, unprofitable. To some, debt default appears eminent, but closer examination reveals that the state-owned corporate debt is backed by domestic deposits, which are owned by the Chinese government. Hence, if these state-owned corporations default on their debt, the government could intervene and forgive the debt at anytime.  Though the government may lose capital by doing so, no other stakeholders would be impacted by such default. In short, it is unlikely that a default by a state-owned enterprise would start a chain-reaction of defaults and instigate a severe financial crisis.

Measures Taken:

Despite the unlikelihood of a financial crisis, the Chinese Government is still very concerned with the rising of debt defaults, which signals inefficiency in spending and heavy reliance on debt-driven growth.  According to Reuters, more than 50% of China’s publicly traded companies are rated unhealthy, or loss-making, when measuring the companies’ ability to repay debt. In order to mitigate this problem, China has been gradually slashing its federal lending and infrastructure spending programs. This strategy serves to decrease the amount of unprofitable investments, thereby reducing the amount of bad debt the government holds. On the other hand, this strategy also reduces overall government and corporate spending, possibly slowing the growth of China’s economy.

(Scarr, 2016)

Outlook:

In order to ensure both stable economic growth and reasonable debt level, the Chinese government must invest in more profitable and beneficial projects while identifying and rejecting loans to unprofitable companies. However, challenges arise when the acceptance or rejection of a project is not solely based on merit, as the outcome could easily be manipulated by acts of bribery. Therefore, political and economical reforms are necessary to improve overall economic efficiency. For now, barring any impactful political or economical reform, China’s debt will likely grow at a reduced rate, as federal lending decreases. The question remains, however, whether the decrease in lending will significantly reduce the amount of future bad debt, or perhaps, only inhibit its short-term growth.

-Jerry Zhang

Sources:

MacFarlane, A. (2017, May 25). China has a huge debt problem. How bad is it? Retrieved August 06, 2017, from http://money.cnn.com/2017/05/25/news/economy/china-debt-economy/index.html

Scarr, S., Still, A., & Wu, J. (2016). China's debt problem explained. Retrieved August 05, 2017, from http://fingfx.thomsonreuters.com/gfx/rngs/CHINA-DEBT-GRAPHIC/0100315H2LG/