China’s debt boom is back on.
The world’s second largest economy added 2.34 trillion yuan ($362 billion) of new debt in March, far exceeding the median forecast of 1.4 trillion yuan in a Bloomberg survey.
The surprising data prompted George Soros to say that the debt explosion in China “eerily resembles what happened during the financial crisis in the U.S. in 2007-08, which was similarly fuelled by credit growth,” according to Bloomberg.
“Most of the money that banks are supplying is needed to keep bad debts and loss-making enterprises alive,” he said.
He added that the unsustainable situation can maintain itself for several years, just like in the US in 2005 and 2006, so the inevitable crash doesn’t have to come immediately.
Not everyone agrees. Analysts at HSBC led by Qu Hongbin are more confident, saying that there are two good reasons for China’s high debt levels, and neither are causes for concern because its economy works differently to the US.
First, here’s how China reached a 249% debt-to-GDP ratio:
A lot of the debt has been driven by the high savings rate of Chinese households. These savings are generally invested in the debt of domestic companies.
Here’s HSBC (emphasis ours):
The high saving rate of households means more surplus savings can be transferred into corporate sector investment.
And here’s the chart:
All those savings have to go into the debt market because the equity market is so underdeveloped.
Here’s HSBC again:
In 2015, debt financing was 95% of the overall financing provided to the economy; equity financing was only 5%.
Significant reforms to the equity fund raising system — from the IPO process to secondary financing and the exit mechanism — are needed to make the equity market a more viable and important funding channel.
In the absence of a developed equity market, economic growth needs to be financed by debt in the form of bank loans and, increasingly, bonds.
But while this highlights the fact that the structure of Chinese financing is different to places like the US, it won’t do much to soothe people like George Soros who expect the good times to come to end painfully.
If companies’ liabilities lie with households rather than the banks, then the prospective losses do to, meaning that any downturn could hit the real economy and consumer spending directly.