China must not choke off the private sector’s access to credit in the name of deleveraging
- With state-owned enterprises soaking up the bulk of bank loans, the economy is in fact underleveraged. Many private businesses depend on freely flowing credit to survive and thrive
- If the government truly wants to build a competitive financial system, it must allow banks to run like banks
For some time, Chinese policymakers have been fearful of rising domestic indebtedness. Their concern is that an overleveraged economy will breed financial instability and lead to economic calamity. As such, Beijing’s monetary and credit policy has been preoccupied by deleveraging, causing the economy to slump from time to time.
It is not an exaggeration to say that China’s deleveraging campaign has often become a key source of weakening global demand and commodity price declines since 2014.
Is China overleveraged? Although widely believed so in the business and economic community, the evidence is not at all clear, and actually suggests otherwise. For example, China is often quoted as having one of the highest private-sector debt to GDP ratios in the world, with total social financing standing at 210 per cent of gross domestic product. This compares with a non-financial private-sector debt to GDP ratio of 150 per cent in the US.
Nevertheless, total social financing is a much broader measure of financing activity that includes not only bank loans and corporate debt issuance but also shadow banking activities and local and central government borrowing. This means comparing China’s debt with that of other nations is often like comparing apples to oranges.
If measurements of debt are adjusted to account for different components and inconsistencies, a different picture emerges.
For example, adding back “shadow banking” activity to the US data, America’s non-financial private-sector debt to GDP ratio is over 240 per cent, significantly higher than China’s. In fact, many Asian economies’ private debt to GDP ratios are much higher than China’s, if debt is measured appropriately.
Meanwhile, there is no question that China’s total bank credit to GDP ratio has surged since 2008, rising from around 100 per cent of GDP in 2007 to over 160 per cent today. Nevertheless, a large part of this jump reflects a sudden spike in government spending and investment during the 2008-2009 global financial crisis.
It is well known that Beijing launched a 4-trillion-yuan (US$577 billion at exchange rates today) stimulus package in 2009 to combat the global financial crisis. This package should have caused China’s budget deficit to shoot up, just like America’s Troubled Asset Relief Programme (TARP) drove its budget deficit to 10.1 per cent of GDP in 2009 from 1.3 per cent in 2007. In reality, this was not the case.
The Chinese government’s fiscal balance barely changed during the 2009-2010 period, but China’s total bank loans jumped by 6.3 trillion yuan in 2009, a 165 per cent surge from 2008. This implies that China’s state-owned banks carried out the government’s fiscal package and entirely financed Beijing’s public investment programme. As such, a large chunk of China’s bank credit is de facto public-sector debt disguised in bank loans.
In fact, there is strong evidence suggesting that China’s economy is underleveraged. According to the World Bank Group, over 85 per cent of bank credit is consumed by state-owned enterprises, which generate only 30 per cent of GDP and 18 per cent of jobs. The private sector, however, consumes less than 20 per cent of bank loans, but produces more than 70 per cent of GDP and creates 80 per cent of jobs.
Therefore, one can legitimately argue that China’s state-owned enterprises are overleveraged, but vast numbers of private businesses are underleveraged.
All of this means Beijing needs to recalibrate its monetary and credit policy and overhaul its financial reform plans. Beijing must stop shooting itself in the foot by pushing the misguided deleveraging policy and allow credit to flow freely.
The Chinese economy has a very high national savings rate and, with banks being the main financial intermediaries, China’s debt levels are naturally higher than most other countries. This is not a sign of economic trouble, but a natural phenomenon associated with all high-saving nations.
Relax. China’s spenders are not borrowing their way into trouble
The Chinese government needs to recognise that it is the state-owned enterprises that need to be deleveraged, while the private sector needs to have more leverage and easier access to credit. That is easier said than done, but regulators should try to level the playing field for private businesses by giving the private sector easier access to bank loans, while ending subsidies to state-owned enterprises via low interest rates. The government should allow financial markets to play the key role in allocating credit and financial resources.
Finally, the Chinese government should stop treating state-owned banks as government agencies. As a first step, Beijing should remove “policy loans” – loans made on government order and which are used to finance the government’s public spending – from state-owned banks and reclassify them as public-sector debt. This way, China’s muddy picture of private- and public-sector debt can be crystallised, and policymakers can make much better informed decisions.
For decades, the Chinese government’s stated goal of financial reforms has been to transform the country’s financial system into one that is market-driven. There have been some reforms and experiments to restructure the financial system but, by and large, reforms have been slow, incomplete and sometimes half-hearted.
If the Chinese government truly wants to build a competitive financial system, it must allow banks to run like banks, and let market forces run their course. Half-hearted reforms or relying on blunt tools to deleverage the economy always create more problems than they attempt to solve.
Chen Zhao is founding partner and chief strategist of Alpine Macro
