By MICHAEL SCHUMAN
SEPT. 7, 2016
The Jiading district of Shanghai. China’s growing debt load has been compared with that of the United States before the 2008 financial crisis. CreditQilai Shen/Bloomberg
BEIJING — The global economy is full of risks right now. Growth is sluggish, and central banks seem powerless to fix it. Europe faces persistent challenges and division. In America, the election looms.
But some say the biggest danger of all may be on the other side of the world, in China.
China is in the midst of one of the biggest borrowing binges in recent history. Its debt load reached $26.6 trillion in 2015 — about five times what it was a decade ago, and more than two and a half times the size of the country’s entire economy. That huge increase has prompted some economists and even the prominent investor George Soros to compare China to the United States before the 2008 financial crisis.
How big a danger does China’s fast-growing debt load present to the country, or the world?
The traditional view is that rapidly rising debt eventually leads to an economic crisis. That can happen in several ways. In Greece, the culprit was the government, which built up more debt than it could handle. In the United States, the risks lurked in the finances of banks and households.
In the case of China, the problem is primarily in the corporate sector. China’s big companies — especially those owned by the state — have done much of the borrowing. Higher debt means companies will have to spend more on interest and paying it back, and less on investing and hiring.
That is where a vicious cycle could come in. Less spending on investing and hiring hurts the overall economy, hitting corporate bottom lines and making it even harder for companies to pay off debt. Bad loans rise. Banks freeze lending. Confidence in the financial system can be shaken, leading to a full-fledged banking crisis.
China, which has the world’s second-largest economy after the United States’, plays a crucial role in generating global growth. Such a situation in China could ripple across the world.
On the other hand, a number of economists say China’s mountain of debt is not as scary as it appears.
Qu Hongbin, chief economist for Greater China at HSBC, and his team argue that China’s debt is simply a result of the way its financial system works. For a variety of reasons, China’s corporations and households stash more money away than their peers in other countries. That cash piles up in banks and is turned into loans, resulting in China’s high level of debt.
Since the debt is backed by all that savings, it is not as risky, Mr. Qu contends. “Concerns about China’s debt levels reaching a critical threshold and posing a systemic risk are overblown,” the HSBC team wrote in April.
Others argue that China’s debt is less of a threat because it is to a great degree backed by the government. Much of it comes from state-run banks, which are the primary lenders to China’s large state-run companies. That means Beijing can stop banks from pushing borrowers too hard and would be more inclined to shore up the financial system, preventing the crisis that a more free-market economy might suffer.
Some experts contend that the risk of China’s debt is lessened because it is backed by the people’s savings.CreditNicolas Asfouri/Agence France-Presse — Getty Images
The debt, too, is largely domestic, making China less likely to be pushed into a crisis by problems outside its borders, which have toppled debt-heavy emerging economies in the past.
Other economies, furthermore, have debt similar to or even bigger than China’s. Debt in the United States, for instance, is roughly equivalent when compared with the size of America’s economy. Japan’s is much larger, at nearly four times the size of its national output.
Still, there is ample evidence to suggest that a large expansion of debt almost always has disastrous consequences.
Neil Shearing, chief emerging markets economist at the research firm Capital Economics, has studied more than 25 years of collapses in developing economies. He concludes that the pace of debt accumulation is more important than the overall level of debt in determining whether a country will face a financial crisis. China’s pace of debt accumulation is well above the threshold he identified as indicating the potential for crisis.
Some economists say that even if China dodges a full-scale crisis, it may not be able to escape the damage caused by its rising debt. They fear that China could fall into a yearslong slump like Japan, which has regularly suffered little or even no growth ever since its own banking crisis more than two decades ago.
In China’s case, the problems created by such an outcome would be much more painful, since it would enter that slow-growth period with its people at a much lower standard of living.
There are already signs that China’s debt is beginning to hamper progress in its economy. China’s banks have increased their lending to try to stimulate the economy, but the actual rate of growth has not picked up. That is partly because China’s economy requires more and more debt to produce the same economic results.
Brandon Emmerich, general manager for North America at Wind Information, a data provider, says $4 of new credit is necessary to generate just $1 of additional gross domestic product — the worst ratio since the depths of the last financial crisis. One reason, Mr. Emmerich recently wrote in a newsletter, is that “most new debt in China goes to pay off old obligations rather than invest in new value-creating projects.”
After analyzing corporate bonds issued in China, he calculated that 42 percent of the money raised since 2015 was earmarked to pay off existing loans or expiring bonds, compared with only 8 percent in 2014.
In an August report, the International Monetary Fund warned of “heightened downside risks” and the need for “decisive action” to reduce the economy’s reliance on credit, including reforming and even shutting down overly indebted companies. “Vulnerabilities are still rising on a dangerous trajectory,” it said.
China has long defied predictions that it is heading for a crash, and perhaps it will prove the doomsayers wrong yet again. But Beijing’s policy makers must limit the increase in debt without inflicting a severe blow to growth. That delicate balancing act is hard to manage, but Beijing may be left with no other choice.
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