The Institute of International Finance estimated that China’s total debt hit 317 per cent of gross domestic product (GDP) in the first quarter of 2020, up from 300 per cent in the last quarter of 2019 – the largest quarterly increase on record. Photo: AP
What is the nature of China’s debt?
Broadly speaking, China’s debt can be divided into domestic debt and foreign debt.
China’s domestic debt, denominated in yuan, consists of three components: corporate, household and government debt. Corporate debt includes borrowings by private sector and state-owned companies, while China’s public debt is a combination of national and local government debt. Household debt, meanwhile, is the combined debt of all people in a household, including consumer debt and mortgage loans.
China’s foreign debt in currencies other than the yuan includes private sector firms’ borrowing from foreign banks, trade-related credit to Chinese firms from foreign trading partners and debt securities issued by Chinese state-owned and private sector firms to foreign investors.
What about the debt the world owes China?
Almost all of this lending is official, coming from the government and state-controlled companies. Over the years, China has been actively lending to emerging economies such as those in Africa. China is also a large holder of effectively funding federal budget deficits in the United States. However, many of the borrowings in developing countries are between governments, and China often does not disclose details or terms of the loans.
China has also been expanding its overseas projects financed by state-backed loans under the Belt and Road Initiative, an ambitious infrastructure investment plan to build rail, road, sea and other routes stretching from China to Asia, Africa and Europe.
An Institute of International Finance report published in May 2020 suggested that China is now the world’s largest creditor to low income countries, with China’s outstanding debt claims on the rest of the world having risen from US$875 billion in 2004 to over US$5.5 trillion in 2019 – more than 6 per cent of global gross domestic product (GDP).
The rise in China’s overseas lending has been mainly driven by increases in bank loans and trade advances, the Washington-based Institute of International Finance (IFF) said. Since the Belt and Road was launched in 2013, at least US$730 billion has been directed to overseas investment and construction contracts in over 112 countries, IIF said.
What is China’s current debt level?
The Institute of International Finance (IFF) estimated that China’s total domestic debt hit 317 per cent of gross domestic product (GDP) in the first quarter of 2020, up from 300 per cent in the last quarter of 2019 – the largest quarterly increase on record.
China’s National Institution for Finance and Development, a government-linked think tank, put the nation’s overall debt at 245.4 per cent of GDP at the end of 2019, up 6.1 percentage points from the previous year.
China’s consumer debt is the fastest growing segment of overall debt, particularly in the form of mortgage and consumer loans. Household debt rose to 54.3 per cent of China’s GDP in the last quarter of 2019 compared to 51.4 per cent in the last quarter of 2018, according to Institute of International Finance.
China’s foreign debt, including US dollar debt, reached US$2.05 trillion at the end of 2019, compared to US$2.03 trillion in the previous quarter, according to China’s State Administration of Foreign Exchange.
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Who owns China debt?
Most of one of the most regular issuers of domestic debt, is held by state-owned or state-controlled financial institutions. For decades, China’s local governments have relied on off balance sheet borrowing through local government financing vehicles (LGFVs).
Many of these borrowings are not recorded and transparency is weak when it comes to how the funds are used. Such hidden debts are estimated to be between 30 trillion yuan (US$4.2 trillion) to 40 trillion yuan by Standard & Poor’s. China also issued 4.36 trillion yuan (US$614 billion) in local government bonds in 2019.
Most these borrowings are held by domestic investors such as commercial banks, followed by policy banks, which are state-owned banks whose investment and lending practises support government policies, such as issuing bonds to raise funds for infrastructure investment and insurance companies.
China’s bond market consists of bonds issued by the national government, local governments, private companies, along with mortgage-backed securities and other asset backed securities. The bond market, the third largest in the world, has steadily grown to over US$13 trillion. Since 2016, it has become accessible to foreign investors through government controlled schemes such as the Bond Connect programme and the Qualified Foreign Institutional Investor scheme.
Foreign investors including wealth managers, mutual funds, family offices and hedge funds held 2.19 trillion yuan (US$308 billion) worth of Chinese bonds in 2019, up 457.8 billion yuan (US$64.4 billion) from 2018. But foreign investors’ presence in China’s onshore bond market remains small, accounting for only 2 per cent of the total holdings.
How has China’s debt level changed?
China’s domestic debt has been growing at an average annual rate of around 20 per cent since 2008, faster than its gross domestic product (GDP) growth. In a bid to counter the impact of the global financial crisis, Beijing unleashed a 4 trillion yuan (US$586 billion) stimulus package in 2008 to boost its economy, which led to a surge in borrowing by local governments and state-owned firms.
But since 2016, China has increased its effort to reduce its debt pile to curb financial risks under a deleveraging campaign led by the central bank.
State firms have been told to reduce their debt levels and lift efficiency, although the process has been slow. The Ministry of Finance has sought to control the hidden risks in local government financing vehicles (LGFVs) by calling out certain regional governments for illegal fundraising in multiple audit reports.
Fitch Ratings report said that around 12.2 trillion yuan (US$1.7 trillion) in government debt, including a material portion of LGFV debt, was converted to public local government bonds between 2015 and 2018 after the State Council sent out guidelines recognising part of LGFV debt as the direct debt of local governments.
The State Council guidelines also stipulated the LGFV debt should be replaced with an equivalent amount of municipal bonds issued by the provincial governments in a bid to improve transparency.
A special purpose bonds quota for local governments were introduced in 2015 specifically to fund infrastructure and public welfare spending. Analysts, such as those from Standard & Poor’s, believe the central government is likely to phase out the LGFV model altogether.
The finance ministry has also demanded a number of heavily indebted local governments clean up their debt and also ordered all provincial officials to regularly report their borrowings in a centralised system since 2019.
After years of rapid growth, China’s external debt has also grown partly because of the country’s push to acquire foreign assets. Its overseas expansion, though, has slowed somewhat since 2015 because of a combination of factors such as sluggish domestic growth, capital and regulatory controls and increasing scrutiny by foreign countries of Chinese investment.
What will impact China’s debt level?
China’s domestic debt level has been mainly driven by its desire to grow its economy as fast as it can. Local government officials’ performance has for a long time been evaluated almost entirely on the basis of their ability to produce economic growth. This incentive structure has been integral to China’s economic success since it began its market reforms over 40 years ago, and as long as China is growing at a reasonably fast rate, borrowers are able to achieve enough profits on their projects to pay off the debts they owe.
But as China’s growth has slowed, there are growing concerns that many of these debts are at risk of default, which could trigger a systemic crisis in China’s state-dominated financial system.
Overseas investment offers China an opportunity to increase trade and business, boosting its own economy.
Beijing’s signature foreign policy initiative, enables China to leverage its economic strength to increase its influence abroad. As such, China’s external debt level will also be affected by its foreign policy objectives under the Belt and Road Initiative.
But China’s increasing overseas lending has raised questions on whether it should continue to receive loans from the World Bank as a developing country. The United States, as the largest shareholder of the World Bank, has objected to lending to China. David Malpass, the American president of the World Bank, has criticised China’s lending efforts to fund its Belt and Road Initiative infrastructure projects, saying the loans leave weaker countries with “excessive debt and low-quality projects”.
Amid criticisms from the United States and European Union and slow growth back home, China has since cut back loans to Latin America, the Pacific Islands and Africa. US-based Rhodium Group estimated that Chinese lending to Africa dropped to US$16 billion in 2017 from a peak of US$29 billion in 2016.
What does the future look like for China’s debt?
Local governments as well as private and state companies that were in relatively poor financial health were already struggling to repay interests to investors as growth slows, triggering a wave of defaults in loan and bond markets since 2019. Rating agencies are expecting more defaults in 2020 in both the onshore and offshore markets.
In May 2020, listed oil and gas firm MIE Holdings failed to make a US$17 million interest payment on its US$248 million bond.
The coronavirus pandemic is likely to slow regional economies even further, driving down local governments’ revenue and impairing their ability to pay off and refinance debt, with the likelihood that some regional economies will have to increase their debt burden. There were already signs of a ripple effect among China’s small banks as the central government had to step in during 2019 to bail out or partially rescue a number of institutions – such as Baoshang Bank and the Bank of Jinzhou – for the first time since the 1990s.
China has asked its banks to extend borrowing to small businesses which may add more bad debts to the financial system going forward because companies may struggle to generate enough revenue due to a poor demand and weak growth prospects.
The overall debt level is also set to rise to a record high in 2020 as China is expected to lift its local government bond quota and issue a special treasury bonds for the first time in 2007 to rescue its
It is not certain whether China will be able to resume its lending and investment sprees in 2020 given that it has to defer and renegotiate past loans across the world as macro conditions deteriorate because of the coronavirus pandemic, according to a report by US-based Rhodium Group in April.
Before the public health crisis, China’s policy banks were already cutting back new loans under the Belt and Road Initiative. Rhodium expected that, given ongoing domestic challenges, China is likely to prioritise investment at home, but still will be able to increase foreign lending through its policy banks. Overseas investment remains an attractive option for Chinese companies given lower valuations of acquisition targets as a result of the pandemic.