Macro Focus – China’s high debt woes

by: Maritza Cabezas

140313-MacroFocus-China-deleveraging.pdf ()
  • China’s high debt continues to increase, but no reason to panic. China’s high and rising leverage, with debt relative to GDP of 240%, has attracted significant attention and caused concern in the markets. Events such as the last-minute agreement that avoided a default by China Credit Trust, a trust fund, and, more recently, China’s first mainland corporate bond default by solar energy firm Shanghai Chaori raise concerns about credit quality in China. We think that although China’s leverage has risen rapidly in recent years, there is no reason to think that it is on the brink of a systemic crisis. Instead we expect that default incidents will likely be incremental in the future, but to a large extent controlled by authorities. Although we think that allowing defaults, particularly of trust funds may cause uncertainty, this will contribute to a healthier financial system in the long run.


  • Corporate debt carries the highest risk, followed by local government debt. At around 170% of GDP, China’s corporate debt is among the highest in the world. The corporate sector includes state-owned enterprises. Many are facing overcapacity and it is unclear whether their earnings will allow them to service their debt. Still, many benefit from strong implicit government support, which suggests that the process of deleveraging could be orderly. Another sector with high risks is local governments, whose debt increased to 28% of GDP in 2013 form 12% of GDP a decade earlier. China’s authorities have once again given the green light to local governments to issue bonds as a way of rolling over their debt. This may be kicking the can down the road, but it also buys time for local governments to improve their debt management.


  • China’s deleveraging: policy driven and gradual. In contrast to the US and eurozone, where the deleveraging process was forced by a crisis, China’s deleveraging has been triggered by policymakers and their willingness to reduce risks. Tighter liquidity conditions, stricter financial regulation and oversight, particularly for shadow banking activities are some of the measures that support deleveraging. We think that China’s leaders will exhibit a preference for gradual deleveraging over the coming period as a means to fine-tune policies and limit any undesired impact on the banking system. China’s authorities are aware that strong economic growth is needed to outgrow its debt. We think that they will even stimulate the economy if necessary to achieve their 7.5% GDP growth target in 2014.