The worriers are back warning us that China has borrowed too much. If China was assessed by the same standards as the advanced world, they would be taking a different view. In China, state debt is only around 40% of GDP, compared to six times that amount in neighbouring Japan. The hostile commentators look at a much wider figure for China, the total borrowings of the state and the private sectors combined. On this measure China has borrowings around 250% of GDP. This is not excessive by world standards.
In China, household debt at 40% of GDP is low in comparison to most western countries. It is also offset by substantial household savings, and a tradition of low mortgage commitments relative to property prices. It is the corporate debt, at 165% of GDP, which is high. Within this the largest amounts of corporate debt are held by state-owned corporations. Often a state owned or controlled bank lends money to a state owned enterprise.
The World Bank and IMF produce figures for total domestic credit to the private sector. Their 2015 figures show China at 155% compared to Japan at 194% and the USA at 190%. It reminds us that the most worrying figure for Chinese debt is the amount borrowed by state corporations and local government.
The fear is that China has overinvested on borrowed money, and will now have to write off a lot of this debt. Some of this is happening already. China has flexibility because this is domestic debt owed by state institutions to other state institutions. China can choose to write it off at a sensible pace, and the Chinese authorities can create new money to keep the affected banks liquid during what is likely to be a prolonged process. It seems unlikely China will want to bring the banks down by writing down too much too soon or being too harsh on determining what is a bad debt.
China has a range of options to manage this. It can say the debt is not bad, because the state can stand behind the state corporation that owes it and meet the payment schedules. The state can require some of the debts to be written off at a pace the state banks can absorb, or it can recapitalise the state banks so they can accept a faster pace of bad debt recognition. No-one can ever be sure a debt is bad unless and until the debtor stops paying, and some potentially bad debts become good credits as trading improves or cashflow picks up.
Like Japan, China has been running a substantial balance of payments surplus. As a result it does not have large amounts outstanding to foreign investors and lenders. Chinese debt is unlikely to bring about a currency crisis because the state does not have to scramble to find foreign exchange to pay for the debts. China retains large foreign currency reserves from its years of generating a surplus.
It is true that China has overinvested, often on borrowed money. For world commodity markets and some of the industrial goods markets to flourish again some of that investment needs to be closed. The closures will require write offs. As they are state enterprises, the state can decide to keep them solvent if it wishes. The main problem investors in China face is disbelief about China, or the hostility of some in world markets. Mr Trump’s anti-China rhetoric in the US has brought more of this out into the open. There are regular investment commentaries highlighting the negatives in the Chinese economy. China announced 6.7% annual growth for the latest quarter. The fact that this was an identical figure to one in each of the two previous quarters, and happened to be in the middle of the official forecast range has led some to query the reliability of these statistics. It is true that the Chinese state could judge the pace of closures and write offs wrongly, denting confidence.
It is easy for bears to go on about Chinese debts. They can also rightly point to past high levels of investment that has produced, in some cases, overcapacity and difficulty in making returns. The Chinese authorities have a big task ahead in cutting capacity in areas like steel and coal. This is difficult in itself, but need not lead to a financial collapse as some fear. The Chinese state holds most of the cards when it comes to the debt burden, so would need to be particularly inept to turn it into a crisis. Meanwhile Chinese shares have had a good year so far, and no longer look cheap. Some will bank their profits, fearing the drip-drip of negative commentary is not going away.
The above article by John Redwood, Charles Stanley’s Chief Global Strategist, was first published by Charles Stanley on 28st October 2016.