China’s debt-reduction campaign a 2021 priority as coronavirus drives surge in borrowing
- Beijing’s latest work report says deleveraging is one of ‘five major tasks’ for the government in 2021
- Since the beginning of the coronavirus pandemic, China’s debt burden has grown roughly 30 per cent
China is set to resume its deleveraging campaign this year, but at a modest pace, as it seeks to balance financial risks with putting excessive downward pressure on an economy still recovering from the coronavirus shock of a year ago.
Beijing’s renewed emphasis on debt reduction – aimed at reducing excess housing inventory and cutting overcapacity in certain sectors – comes amid official warnings about the impact of the massive US coronavirus relief effort on America’s already high debt burden. It also follows concerns about domestic and foreign risks emanating from China’s debt position.
After the global financial crisis in 2008, the United States and China opened the financial floodgates to support their economies, causing debt levels to surge in both countries. In response to the coronavirus pandemic, the US Federal Reserve and the People’s Bank of China once again loosened monetary policies to drive down borrowing costs, causing the debt burden of both nations to hit record highs.
Guo Shuqing, chairman of China Banking Regulatory Commission, warned last week of the pressures from high leverage in the financial system, because a considerable number of Chinese companies were likely to face bankruptcy and liquidation after the pandemic.
With their operations disrupted, many will have difficulty paying off debt, leading to an inevitable rise in non-performing bank loans, Guo said.
Since the beginning of the pandemic, China’s debt burden has grown roughly 30 per cent, becoming the second most indebted country after the US, according to the Bank of International Settlements (BIS), the international organisation representing the central banks of the world’s largest economies.
China’s total credit to the non-financial sector – corporations, households and the government – rose to US$41.6 trillion in the third quarter last year, while the US debt burden ballooned to US$60.9 trillion in the same time frame, BIS data showed.
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China’s situation is more worrying when considering that the primary source of its high debt comes from the corporate sector, as its borrowing costs are higher than the government’s. The ratio of China’s non-financial corporate debt to GDP reached 163.1 per cent in the third quarter – roughly double the 83.5 per cent ratio in the US, according to the BIS.
At that time, several Chinese economic indicators showed that critical debt levels could have caused systemic financial risks or even a financial crisis, prompting the campaign to cut debt owed by local governments, financial institutions, businesses and households.
China’s total debt accounted for 250 per cent of GDP in 2018, little changed from 2017 after the first couple of years of deleveraging efforts.
As a result, the debt-to-GDP ratio did not decline further, but instead rebounded to 258 per cent in 2019, before shooting up further to a record of 285 per cent in the third quarter of 2020 as China pumped more money into the economy in response to the pandemic.
Another economic indicator showing how ineffective China’s deleveraging efforts have been is the ratio of broad M2 money supply – which includes cash and checking deposits – to GDP. In 2016, the level of M2 accounted for 207 per cent of GDP, the highest M2 ratio of any country in the world. The ratio fell back to 195 per cent in 2018 but rebounded to 197 per cent in 2019 before rising to 215 per cent in 2020.
In contrast, the US managed to keep its M2-to-GDP ratio at around the 100 per cent level during this period.
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Strong policy support has been vital for the post-coronavirus economic rebound in China after a sharp contraction, and has also suppressed credit risks temporarily. But the Chinese economy entered the crisis with already unfavourable credit risk conditions, and these vulnerabilities have increased following the pandemic shock, analysts said.
A leading school of economic theory says that a country will always need to borrow more in subsequent years than it borrowed in the first year, because more money needs to be injected into the economy. Trying to reduce debt would cut spending and risk a potential recession, leading to a bigger problem.
The higher the debt ratio, the less likely the credit will be paid back, and the higher the risk of default, according to the theory.
China’s high debt-to-GDP ratio is an international concern, as China accounts for 20 per cent of total global debt, analysts said.
Regulators acknowledge the importance of containing leverage and the vulnerability of many banks
“From 2017 to 2019, what happened was that non-financial corporations were in fact deleveraging, but government debt and household debt were growing more quickly than gross domestic product,” said Erik Norland, senior economist at financial exchange firm CME Group. “So, it was kind of taking debt out of one area and moving it to another area. Actually reducing the [overall] debt ratio is a very difficult thing to do.”
While authorities have shown a commitment to regulatory reforms designed to curb systemic risks and to stabilise system leverage, questions have been raised about how objectives can be achieved when the priority is maintaining economic growth.
China would need to ensure domestic demand continues to grow sufficiently to offset the economic losses from the deleveraging campaign.
“Regulators acknowledge the importance of containing leverage and the vulnerability of many banks,” said Elaine Xu, an associate director at Fitch Ratings. “Nonetheless, there remains a risk that regulatory shifts could undermine the reform efforts made in recent years, as banks remain highly influenced by macroeconomic directives.”
The government did not specify a numerical target for M2, but suggested that its growth should be basically in line with nominal GDP growth.
As expected, the government trimmed its fiscal stimulus, cutting the central government budget deficit target to 3.2 per cent of GDP from the 3.6 per cent target set in 2020. But it remains slightly higher than the average historical ceiling of 3 per cent in the years before the pandemic, suggesting only a gradual exit from the extra economic support.
In particular, prudent monetary policy should be more flexible, targeted and reasonable, ensuring reasonable and sufficient liquidity and keeping macro leverage basically stable, the government said.
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“This year’s expected economic recovery will likely improve corporate revenue and ease the pressure for debt. But it is still hard to say if China’s debt-to-GDP ratio will fall for certain, especially given uncertainties from the technology war and a rebound in the pandemic,” said Iris Pang, chief economist for Greater China at ING Bank.
The risks are rising for China’s financial sector, especially if non-performing loans increase sharply, making it difficult for many banks to meet their capital adequacy requirements.
Liu Qiao, dean of Peking University’s Guanghua School of Management, said late last year that a problem in China was the overemphasis on the size of the finance sector in the overall economy, instead of concentrating more on the sector’s structure and quality.
“The real economy does not benefit from this,” Liu said. “From the perspective of financial support given to the real economy and the efficiency of resource allocation through finance, China’s financial system still has a long way to go.”
