Lights and Shadows on Chinese Debt

Those who bear following me a bit know that, with greater or lesser intensity, in general, I have always been relatively confident about the outlook of the Chinese economy. This increased confidence compared to consensus is not due to a matter of perception or less risk averse but some differences in the way of approaching the issue.

A critical point for understanding the level of debt in China, but rarely pay any attention, is the differential fact that much of this country’s debt is contracted with itself: meaning debt is between different governments agencies but, ultimately depend on the State-Party structure. From the point of view of the loans, as you know most of the banking system is state-owned. Similarly, almost all borrowers are SOEs (State-owned enterprises) and local governments. In other words, the Chinese government has issued debt to itself. Therefore, if we make a netting between different assets and liabilities that accumulate at different levels of government, we would find that the total leverage of the Chinese economy is substantially reduced.

There are several elements that help to understand these dynamics. First, government entities have had (and continue today) ease of access to credit. On the other side, the market-driven economy, where Chinese export sector is concentrated, does not enjoy this ease of access. That is why, today, the average private sector leverage is very low: only 30% of total debt of China, which is estimated at 220-240% of GDP, although this represents approximately 80 % of GDP. Likewise, the household debt is relatively low compared to any country around us reaching to near 35% of GDP levels. In fact, households’ savings in the form of bank deposits, are more than double the liabilities. Thus, Chinese households have certainly a more solvent liquidity buffer to deal with contingencies.

Having said that, investors worried about a hypothetical Chinese debt crisis can basically argue risks as far as the central government is unable, or unwilling, to maintain certain credit to SOEs and local governments who, being in a position to insolvency could not therefore meet its payment obligations. This, in my view, is not a concern if we again look at the data.

Latest estimates for the central government debt is 15% of GDP, a relatively low figure and also ignores the huge foreign exchange reserves and has the nation amounting to about 4 trillion dollars (c. 40% of GDP).

With the numbers in hand, it seems clear that Beijing leaders have sufficient fiscal margin to rescue (or not) those public enterprises and local governments see fit when they think they should. I pointed out some time ago when the first news of the bankruptcy of Chinese companies jumped suddenly and took more than one person on the wrong foot: balance Chinese management today is primarily a political issue where the Chinese elite, and very especially premier Li Keqiang and his closest circles, have to decide how to manage the timings to push forward reforms which a condition sine qua non for China to continue on the path of prosperity, without this implying a threat to the leadership of party in them as well.

In two words: high politics.

What can we expect in the short-medium term? Hard to say, especially considering the relatively low transparency of the regime and the unfathomable character of its leaders. However, in the opinion of this analyst, given the propensity of many local leaders (caciques to say) drive mammoth projects in most times basically for self-aggrandizement, it seems logical to think that we will see more “orderly bankruptcy” in coming months as the system refines its excesses in an orderly manner. As I said at the time, these failures serve as warning to the lower cadres of the Party and government agencies to take note of the new air breathed in the capital. In any case, I venture to rule out a hard landing scenario.

In short, the Chinese economy is facing a moment of some anxiety that from the West we often tend to aggravate automatically simply because of the difficulty (justified) to obtain a clear and complete view of the performance, mechanisms and singularities of the Chinese economy. My thesis is that although there are some risks, concentrated in certain regions and sectors, the country has reserves -in the literal and figurative sense- sufficient to address the imbalances that characterize the current situation and, in the medium to long term, continue their historical process of economic convergence towards Western standards.