China is underestimating its US$3 trillion dollar debt and this could trigger a financial crisis, says economist
- Property developers and other mainland companies and investors that have borrowed dollar-denominated debt at low US interest rates are now facing repayment problems due to Federal Reserve rate increases and stronger greenback
Massive domestic debt has long been a headache for Beijing, but it is China’s growing external US dollar leverage that is being underestimated and it could possibly trigger a major financial crisis, according to Kevin Lai, chief economist for Asia excluding Japan at Japanese investment bank and securities brokerage Daiwa Capital Markets.
China’s US$3 trillion dollar debt makes it especially vulnerable because of tightening US dollar liquidity, a weakening yuan and the ongoing US-China trade war, said Lai.
Is China about to let the yuan weaken below seven to the dollar?
Global dollar debt outside America has risen to US$12 trillion today from US$9 trillion in 2013, according to Lai. Of that total, 25 per cent, or US$3 trillion, has been borrowed by China Inc and its subsidiaries in Hong Kong, Singapore and the Caribbean. China’s US dollar cross-border claims have risen faster than any other emerging economy’s despite its partially closed capital account.
In response to two financial market challenges – the “taper tantrum” in 2013, when the US Federal Reserve started tightening monetary policy; and an attempt by the People’s Bank of China to reform the exchange rate in August 2015 – China took on even more dollar debt, instead of paying it down and resolving fundamental issues with corporate efficiency and governance.
“Can this trade war push the world’s dollar debt further to US$13 trillion or US$14 trillion?” said Lai, adding that the size of dollar debt globally was probably peaking given US dollar tightening. This would lead to investors selling their assets to get back their dollars and paying back their dollar debt. “We will be talking about a major financial crisis – a dollar debt crisis.”
The amount of dollar debt raised by China in its offshore centres that has entered its banking system is worrying given the prospect of further depreciation pressure on the yuan’s exchange rate, said Lai.
Traders, investors and their clients have in the past taken advantage of a lucrative spread between US and Chinese interest rates to borrow cheap dollar debt and convert it into higher yielding yuan-denominated assets.