What we don’t see in China’s debt risk?

10 May 2017

A bend in the road is not the end of the road…unless you fail to make the turn. – Unknown author

  • China has started tackling its debt problem through practical means. However, a policy to cut the country’s debt-to-GDP ratio swiftly, as some have urged, could crush the economy before the benefits of debt reduction could even emerge.
  • China’s debt risk lies in its rapid rate of accumulation. The debate on the problem has predominately focused on the liability side of the economic balance sheet. But it misses the asset side of the balance sheet that has growth implications from the debt accumulation.
  • The coexistence of excess-capacity and under-investment in China is clouding the analysis of its debt as there is a lack of understanding of this conundrum. Headline data gives an incomplete picture of China’s debt risk and, hence, may distort its strategic outlook.


The amount of China’s debt (which is predominately bank loans) is not as excessive as the news headlines have painted (Chart 1). Contrary to conventional wisdom, China’s debt is also structurally stable as it is funded by domestic savings and managed under an implicit guarantee policy (from which Beijing is retreating only slowly) and a relatively closed capital account1. The risk stems from its rapid rate of accumulation in recent years (Chart 2), which raises the alarm of capital misallocation leading to a financial crisis eventually.

Deleveraging can’t go fast

Beijing is not in denial of this risk, though it has been criticised for moving too slowly to cut debt. To be fair, a policy to cut China’s debt-to GDP ratio swiftly, as many players have urged, would be implausible. This is because aggregate financing growth has outpaced nominal GDP growth by an average of six percentage points since 2012 (Chart 3). To cut debt abruptly would mean slowing credit growth by more than six percentage points below the nominal GDP growth rate. This could crush the economy before the benefits of deleveraging could even emerge.

The government has taken a practical approach to deleverage. It started a debt-swap programme in 2015 to pare the debt burden of the local government financing vehicles2, implemented a debt-equity scheme to deal with non-performing bank loans3 and set up provincial asset management companies to absorb regional bank loan losses. Despite the stock market’s volatility, it has also encouraged equity financing (Chart 4) to channel domestic savings into the economy to reduce its reliance on debt for growth.

With growth concerns now easing, deleveraging has moved up the policy priority list. This can be seen from the PBoC’s continued effort to use economic stabilisation as a cushion to force deleveraging through small “surgical” tightening4. Furthermore, the PBoC started to implement its Macro Prudential Assessment (MPA) framework in 1Q 2017, which has resulted in some initial debt reduction.

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