Chinese debt levels have grown at an enormous pace in the seven years since the global financial crisis, adding to existing concerns over financial stability in China’s financial sector that flared earlier this year.
While those concerns have since subsided into the background, courtesy, in part, to another wave of central bank monetary policy stimulus that saw markets recover strongly since the depths seen in mid-February, the problem has not gone away.
To many, it’s not a matter of if these concerns will resurface, but when.
As this chart from the National Australia Bank (NAB) reveals, there’s a good reason why these concerns are likely to come to the fore yet again at some point in the future.
It shows China’s credit-to-GDP gap — the percentage that the current ratio exceeds its long term trend — based on analysis from the Bank of International Settlements (BIS) that was released earlier this month.
At 30% at the end of the March quarter this year, the ratio was three times larger than the 10% threshold the BIS deems to be an early warning signal that debt accumulation levels may be unsustainable.
While there are other nations above this so-called “danger level”, including Hong Kong, the pace of credit growth in China stands head-and-shoulders above the rest.
At a time when Chinese policymakers have turned to infrastructure and residential property construction — pillars of the “old” China growth model — to help bolster economic growth, it does raise questions over whether the relative calm towards the Chinese economy in recent months will last.
According to Gerard Burg, senior Asia economist at the NAB, the widening in China’s credit gap is nothing new, rather a continuation of the trend seen in recent years.
A trend that based on research from the BIS is amplifying financial stability concerns to ever-greater heights.
“While this result generated a considerable amount of press attention, the story is not new – China’s credit gap exceeded 10% for the first time in September 2009, and only briefly dipped below this mark during 2011 and early 2012, prior to fresh stimulus to underpin economic growth,” Burg wrote in a research note released last week.
“In a large part, this reflects the growth of China’s shadow banking sector from around 2012 onwards, initially in response to the attempts of authorities to limit the growth of traditional credit.”
As a result of this surge in credit growth, Burg estimates that China’s total debt level, including government debt, now stands at 315% of GDP, even higher than estimates offered by the BIS itself.
“The size of the shadow banking sector is often under-estimated – including by the BIS – leading to an inaccurate picture of China’s overall debt level,” suggests Burg.
“The distinction between these differing measures is significant when making international comparisons.
“Either measure puts China above the average for advanced economies (at 245%), however our measure places China among the highest debt advanced economies – an unprecedented position for a still developing economy,” he says.
To Burg, the enormous existing debt level, coupled with the acceleration higher in the nation’s credit gap, “demonstrate that the efficiency of China’s debt is decreasing”.
The new debt is delivering less bang for its buck in terms of economic activity, in other words, as highlighted in this excellent piece last week.
“Some lending to large SOEs [state-owned enterprises] is used to roll over existing debts, or continue funding uneconomic operation,” says Burg.
“This lending fails to add meaningfully to GDP, as well as crowds out other potential borrowers – usually private sector firms, who are either unable to access finance or seek higher cost funds from the shadow banking sector.”
Burg estimates that 84% of China’s private sector credit is contained in the business sector, of which around half is held by SOEs. This compares to the 22% level these firms contribute to Chinese economic output, based on analysis from the IMF.
“The IMF has warned Chinese authorities to address these issues – noting that banks are holding an increasing number of non-performing loans and that recent credit growth is exacerbating the problem,” he says.
Burg suggests that underlines the conundrum facing Chinese policymakers — either they let growth slow by pulling back on credit growth or keep accumulating debt in order to bolster short-term growth, creating medium-term risks surrounding financial stability.
“We do not anticipate a Chinese financial crisis in the short term,” he says.
“This largely reflects the low level of foreign debt, the still relatively restricted capital account and the level of state control in the banking sector.
“However, continuing to allow credit growth – particularly to highly indebted SOEs – adds to medium term risks for China.”
The concern expressed by Burg followed a warning from ratings agency Fitch who suggested last week that the real level of Chinese bad debts could be more than 10 times larger than the official 1.8% level reported by the government.
“NPL [non-performing loan] rates could already be as high as 15%-21% for the financial system,” the group wrote, suggesting that a government bailout of the banking system of anywhere between $US1 to $US2.1 trillion “will ultimately be needed to help address China’s debt overhang”.