China's debt: Coming clean
AS ANYONE who has conquered addiction knows, the first step is admitting that you have a problem. China, hooked on debt for much of the past decade, may be reaching that point. In recent weeks officials have talked at length about the country’s troubling reliance on credit to fuel growth. They have also sketched out a range of possible solutions. It is only a start—withdrawal symptoms in the form of defaults and slower growth are sure to hurt, and could yet prompt a relapse. But the new tone is encouraging nonetheless.
The frankest admission came in a front-page article in the People’s Daily, mouthpiece of the Communist Party, in early May. An anonymous “authoritative person”, widely believed to be Liu He, an economic adviser to President Xi Jinping, warned that high leverage could spark a systemic financial crisis. China’s total debt load jumped from less than 150% of GDP in 2008 to more than 250% at the end of last year. Increases of that size have presaged economic trouble in other countries.
Last month the government convened its first news conference on the topic, bringing together officials from the finance ministry, the central bank, the banking regulator and a top planning agency. The Chinese Academy of Social Sciences, a prominent official think-tank, has also opined on it. The research arm of the central bank has published a paper with a section on what can be done. And this week, a forum in Beijing gathered officials, bankers and academics to sift through the suggestions.
All of them have homed in on corporate debt as the main worry. That is obvious enough from a quick comparison with other big economies: China sits in the middle of the pack for total debt but is at the high end for corporate liabilities (see chart). Yet it marks a change of tone from recent years, when officials focused on cleaning up the debt of local government. This presented a more immediate but smaller problem, and also a more manageable one.
The most important outcome from all the discussions has been an outline, albeit rough, of how China hopes to tackle its burden. There will be no rush to deleverage. Sun Xuegong, a central planner, said China would start by slowing the rise in its debt-to-GDP ratio before guiding it lower, trying to avoid too much collateral damage to the economy in the process.
Officials think they can cushion the blow from eventual deleveraging in three ways. First, they want to get more bang from new debt. That, in theory, means choking off credit to underperforming state-owned firms or restructuring them in the image of their sleeker private-sector peers. Loans would flow to better firms generating higher returns.
Second, they want equity financing to help replace debt. That is tough, given the woeful state of the stockmarket after last year’s crash. But there are other ways. Regulators are working on a programme under which banks will swap some loans to indebted companies for equity stakes instead. Banks have pushed back, fearing that they will be saddled with bad investments. Officials insist that only viable companies will receive this treatment.
Finally, the government will use fiscal policy to prop up growth, in effect transferring debt from corporate balance-sheets to its own. That makes sense: official public debt is low, at less than 50% of GDP, while state-owned companies are the biggest debtors. However, direct bail-outs would give state firms little reason to improve their operations. So the central bank’s researchers suggest other measures, such as tax cuts, which would improve the business environment for all.
Scepticism about whether China will end its credit binge is warranted. Last December the government identified deleveraging as one of its main tasks for 2016. Yet credit issuance has outpaced economic growth by a wide margin, raising overall debt levels. And China’s approach to state firms is inconsistent. Officials recognise that getting them to operate more like private firms, constrained by budgets, is critical to controlling debt. But at the same time the Communist Party recently reiterated that they must obtain its approval before making any big decisions. China is sure to keep one promise, at least: there will be no speedy resolution to its debt problems.
The frankest admission came in a front-page article in the People’s Daily, mouthpiece of the Communist Party, in early May. An anonymous “authoritative person”, widely believed to be Liu He, an economic adviser to President Xi Jinping, warned that high leverage could spark a systemic financial crisis. China’s total debt load jumped from less than 150% of GDP in 2008 to more than 250% at the end of last year. Increases of that size have presaged economic trouble in other countries.
Last month the government convened its first news conference on the topic, bringing together officials from the finance ministry, the central bank, the banking regulator and a top planning agency. The Chinese Academy of Social Sciences, a prominent official think-tank, has also opined on it. The research arm of the central bank has published a paper with a section on what can be done. And this week, a forum in Beijing gathered officials, bankers and academics to sift through the suggestions.
All of them have homed in on corporate debt as the main worry. That is obvious enough from a quick comparison with other big economies: China sits in the middle of the pack for total debt but is at the high end for corporate liabilities (see chart). Yet it marks a change of tone from recent years, when officials focused on cleaning up the debt of local government. This presented a more immediate but smaller problem, and also a more manageable one.
The most important outcome from all the discussions has been an outline, albeit rough, of how China hopes to tackle its burden. There will be no rush to deleverage. Sun Xuegong, a central planner, said China would start by slowing the rise in its debt-to-GDP ratio before guiding it lower, trying to avoid too much collateral damage to the economy in the process.
Officials think they can cushion the blow from eventual deleveraging in three ways. First, they want to get more bang from new debt. That, in theory, means choking off credit to underperforming state-owned firms or restructuring them in the image of their sleeker private-sector peers. Loans would flow to better firms generating higher returns.
Second, they want equity financing to help replace debt. That is tough, given the woeful state of the stockmarket after last year’s crash. But there are other ways. Regulators are working on a programme under which banks will swap some loans to indebted companies for equity stakes instead. Banks have pushed back, fearing that they will be saddled with bad investments. Officials insist that only viable companies will receive this treatment.
Finally, the government will use fiscal policy to prop up growth, in effect transferring debt from corporate balance-sheets to its own. That makes sense: official public debt is low, at less than 50% of GDP, while state-owned companies are the biggest debtors. However, direct bail-outs would give state firms little reason to improve their operations. So the central bank’s researchers suggest other measures, such as tax cuts, which would improve the business environment for all.
Scepticism about whether China will end its credit binge is warranted. Last December the government identified deleveraging as one of its main tasks for 2016. Yet credit issuance has outpaced economic growth by a wide margin, raising overall debt levels. And China’s approach to state firms is inconsistent. Officials recognise that getting them to operate more like private firms, constrained by budgets, is critical to controlling debt. But at the same time the Communist Party recently reiterated that they must obtain its approval before making any big decisions. China is sure to keep one promise, at least: there will be no speedy resolution to its debt problems.
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