Why China’s debt is not worth losing any sleep over, just yet
Lawrence J. Lau argues that public debt is still low by world standards and at manageable levels, but what should be tackled is the debt-to-equity ratio
There has been a great deal of discussion lately about the level of total Chinese debt relative to national GDP. However, some of the conclusions reached may have been influenced by a misunderstanding of the actual situation. There is public debt, and then there is other debt – they should not all be treated as the same.
First, public (central government) debt in China is low, estimated to be around 20 per cent of gross domestic product, the lowest among major economies (for example, it is 250 per cent for Japan and around 100 per cent for the US). This is recognised by almost every observer of the Chinese economy.
Second, even if all the explicit local government debt (41 per cent of GDP at the end of 2015, according to the International Monetary Fund) is included as contingent central government liability, the total of 60 per cent is still low by world standards, and certainly so for an economy with a GDP still growing at between 6 and 7 per cent a year. It is actually most unlikely that all of the local governments will ultimately require a bailout by the central government.
Moreover, almost all government debt is denominated in renminbi, so there is no question about the ability of the central government to repay its debt, just as the US can always repay its dollar-denominated debt by printing more money. Furthermore, Chinese debt is mostly held by Chinese nationals, either individuals or institutions, so that it is similar in nature to intra-family debt and can be sustained for a long time if necessary.
However, most analysts are focused on the total debt of the Chinese economy, rather than just the explicit public debt. They would include the debts of state-owned enterprises, of local government financing vehicles, as well as private enterprise and household debts, arriving at a total debt ratio of approximately 255 per cent of GDP (according to the Bank for International Settlements). Of course, the corresponding comparable ratios for other economies will also become much higher (for example, Japan’s ratio rises to almost 400 per cent). The Chinese ratio is still far from being the world’s highest.
SOE debts are included on the assumption, not necessarily true, that the central government will eventually have to assume these debts if they ever turn sour. But unlike ordinary public debt, the central government has no explicit or implicit responsibility for these debts.
More fundamentally, the SOEs collectively have a positive net capital value (many are publicly listed companies). So, if their debts are to be included, so should their assets. It is therefore misleading to treat the debts of SOEs as if they were the same as ordinary public debt.
Similarly, the debts of local government financing vehicles are also included. However, these do not even have a local government guarantee, let alone a central government guarantee. One cannot assume that if these loans become non-performing, the government will automatically make good on them. The Guangdong International Trust and Investment Corporation experience should be cautionary. In any case, project-related debt should not be included as part of the current budget deficit – there is a distinction between current and capital accounts.
Many public infrastructure projects are undertaken not because their pecuniary returns are high but because of the non-pecuniary benefits and the positive externalities they generate. An example is an urban mass transit system, which reduces carbon emissions, air pollution and congestion, and saves time for everyone.
In fact, if public infrastructure projects have the same rate of return as private investment projects, it is prima facie evidence that there has not been enough investment in public infrastructure projects.
Chinese household debt is low as a percentage of GDP, slightly more than 30 per cent, because Chinese households are significant net savers without much borrowing, except possibly for their residential mortgage loans. In contrast, enterprise (including SOE) debt as a percentage of GDP is relatively high. The high ratio of enterprise to household debt has caused concern in some quarters.
There are, however, good reasons for the high enterprise debt, other than losses. First, many of the enterprises have been waiting for a long time to be listed on the Chinese stock exchanges so that they can raise some equity capital. In the meantime, they have had to continue borrowing. Thus, enterprise debt can be substantially reduced if the rate of initial public offerings is accelerated. In addition, one can also facilitate the issuance of additional new shares by listed enterprises.
Second, the high total enterprise debt can be due in part to double counting because of re-lending by borrowers. For example, an enterprise with a good credit rating can borrow from a bank and then re-lend the proceeds to another enterprise at a higher rate of interest, pocketing the difference. The same credit will then count twice, whereas it would count only once if the bank had lent directly to the second borrower. But it is the same debt and the same ultimate risk. Of course, the second borrower may further re-lend what it has borrowed. These practices have led to a mushrooming of the total enterprise debt.
Can such re-lending be stopped? Yes, if the lender takes seriously the stated purpose of the loan and only disburses the proceeds to the relevant contractors, suppliers and vendors directly, eliminating the opportunity for the borrowed funds to be diverted for re-lending or other unauthorised purposes.
Of course, what really matters is not total debt per se, but the debt-to-equity ratio, on both the microeconomic and macroeconomic levels. A high debt-to-equity ratio encourages moral hazard and reckless risk-taking, and potentially leads to financial instability. While China should definitely work to lower its overall debt-to-equity ratio, the total debt outstanding per se is still manageable.
Should we worry about the Chinese debt? Yes, but we should not lose too much sleep over it, at least not yet.
Lawrence J. Lau is the Ralph and Claire Landau Professor of Economics at the Chinese University of Hong Kong