Will China’s rapid credit boom of recent years end in an inevitable bust? According to asset manager Blackrock, history is not on China’s side. Their research, citing IMF data, points to only four other credit booms of similar magnitude in China over the past 50 years. On all four occasions they ended in a banking crisis occurring within three years.
It’s not a good omen for markets, or indeed, the global economy.
Blackrock, citing a study by consultancy group McKinsey, says that between 2007 to 2014 total debt accumulated in China ballooned by $21 trillion. That increase took total Chinese debt as a percentage of GDP from 158% to 282% in just eight years.
The chart below shows the explosion in debt accumulation in China from 2000 to 2014. Most of the debt issuance is corporate which, according to Standard and Poor’s, made the nation’s corporate debt market the largest in the world, surpassing the US in 2013.
While the rapid acceleration in debt issuance initially fuelled economic growth, Blackrock says it’s now losing its potency to spur increased economic activity.
“China has been taking on increasing amounts of debt to maintain growth. Yet it has been getting less bang for its yuan as growth has edged down. Credit growth is not just losing its potency; it is turning into a poison. Debt is growing faster than borrowers’ ability to service it. The resulting debt mountain stood at $28.2 trillion at the end of 2014, according to a McKinsey report. The debt cannot be rolled over indefinitely. China’s debt-to-GDP ratio has reached almost 300%. Government debt makes up a relatively small share of the total, with the bulk in the corporate sector”.
While the debt burden is creating amplified financial risks, Blackrock believe the fallout of any potential debt crisis could be limited by the Chinese government’s effective ownership and control of the nation’s banks, and the fact China’s economy is still a relatively closed.
Here’s their assessment on the government’s attempts to limit the threat of a debt crisis occurring:
“There are signs credit growth is finally starting to slow. Steps to rein in China’s ‘shadow banking’ sector (non-bank financing) have put the brakes on lending growth. See the chart above. The key is increasing the quality of credit. This means funnelling more money to the private sector – and less to China’s two biggest credit junkies, local governments and state-owned enterprises (SOEs).
Many local governments and SOEs can no longer service their debts, let alone pay them back. A quick way to deal with the issue would be to nationalise local debts. The government has resisted this step so far (it would reward profligate spenders). Beijing instead is trying to bring bank loans racked up by murky local government financing vehicles (LGFVs) into the open and eventually convert them into bonds. The goal is to swap short-term, high-interest bank debt into long-maturity, low-interest bonds. This would provide debt relief and support the growth of a municipal debt market. The devil is in the details: the plan would just shuffle debt from one pocket to the other if (state-backed) banks were to buy all the bonds, in our view”.
While Blackrock are clearly are cautious on this response, if risks within Chinese debt markets amplify, they believe it will create little systemic risk to the global financial system.
“The good news for investors? China poses little systemic risk to the global financial system. It is still a relatively closed economy. Foreign banks’ claims on China have been rising fast (a red flag), but are just a fraction of domestic banks’ lending”.
That may be so, but if a debt crisis develops within China, it’s unlikely that the global economy would escape the consequences, particularly nations heavily reliant upon China for their own economic prosperity.
Let’s hope those theories are never tested.