Are China’s overall debt levels manageable?

In a Bloomberg Online news article, published on October 10, 2013, entitled, “IMF’s Zhu Says China Has Tools to Deal With Debt Levels”, the news article quoted a comment made by Mr. Zhu Min, a former deputy governor at People’s Bank of China (PBOC), and current managing director at the International Monetary Fund (IMF), noting that the Chinese government has room to deal with rising debt levels, which he regarded it as a “serious concern”. Mr. Zhu cited some of the reasons why China is able to manage its debt levels, including the country’s nearly USD 3.5 trillion in foreign reserves, current government actions to actively tackle the issue of borrowing excessively through curbs put in place, which will reduce the chances of a “hard landing”.

However, these remarks did not seem quite convincing, given that independent credit rating agencies, including Fitch Ratings, Inc. estimates the China’s total credit, including off-balance sheet loans, have increased to approximately 198.0 percent of gross domestic product (GDP) in 2012 from 125.0 percent four years earlier. This statistic looks quite startling, given that it is slowly approaching to the approximate debt levels to overall GDP of Japan during the 1990s, which had a record of over 200.0 percent debt-to-total GDP ratios, and the real estate bubble burst, causing the Japanese economy to slip into decades long recession.

There are some further evidence of China’s overall debt levels which might suggest otherwise, including the issue of ‘Shadow Banking’, where ordinary Chinese people and businesses sought to borrow and/lend based on private transactions, including financial transactions being conducted through among individuals and businesses, auto finance business, and very small loan firms. The various vetting procedures for documentation proofs of income levels, as well as other loan verifications were not being conducted through the official banking system, instead these transactions are done through firms operating in the shadow banking system and who are willing to market their loan services with some degree of anonymity guaranteed to the loan applicants.

In another Global Times news article published on October 09, 2013, entitled “Shadow Banking seen accounting for 40.0% of GDP: report”, it mentioned that the size of China’s shadow banking sector reached approximately 20.5 trillion Chinese Yuan (USD 3.4 trillion) by the end of 2012, which is equivalent to roughly 40.0 percent of the country’s GDP during 2012. The statistic was drawn from data published by one of the Chinese government think tanks, the Chinese Academy of Social Sciences (CASS), on October 08, 2013. The latest report differed from the official statistics, where it estimated that the size of the shadow banking system in China was 14.6 trillion Chinese Yuan by the end of 2012, or approximately 29.0 percent of the country’s GDP. In addition, CASS reported that the shadow banking sector’s share of China’s total banking assets was approximately 16.0 percent by end of 2012, higher than the official Chinese government estimate of 11.0 percent. CASS noted that the official statistics only include wealth management products marketed by banks and assets managed by trust firms, but did not include other sectors of the banking system, including the auto-finance firms, small-loan firms, etc.

With the two differing analysis on China’s management of its overall debt levels, one coming from a former PBOC deputy governor, and the other coming from the government think tank, the Chinese Academy of Social Sciences (CASS), I believe that nobody knows exactly just how much loans, and other forms of debt are existing in China’s financial system, due to the various methodologies applied in their data collection. This poses a serious issue on the level of transparency and full disclosures being practiced by many of these Chinese firms operating in the financial services sector. There is no true account of most of the finance companies’ loan books, including the number of loan applications, impairments, cures, off-balance sheet loans, the existence of proper vetting procedures, etc. Although there are assurances made by former and current officials from the PBOC that China is able to weather any credit crisis based on the amount of reserves that the Chinese government has, however there could be risks if credit limits, and enforcement measures are not being put into practice. This is because a credit event is seldom controllable, given what happened during the mortgage crisis which brought about the 2008-2009 Global Financial Crisis (GFC), and nearly brought the world’s number one economy, the United States, down to its knees. It is certainly risky to dismiss the overall issues regarding the existence and prevalence of the shadow banking system in China.

The Chinese government should be actively investigating and keeping tabs of some of the official statistical account regarding the size of the shadow banking system. There should also be widely recognised method of data collection when compiling such information, as there is already too much ambiguity and confusion in the past over the integrity of the data released by the Chinese government.

This issue has also been in much focus in late June 2013 when there were rumours of a cash crunch happening in the Chinese banking system which sparked off a week-long global market selloff, before the PBOC decided to step in and eventually brought the domestic interbank rates down. I believe that despite the comments made by the former deputy governor of the IMF that tries to paint a somewhat optimistic picture that China is able to manage its overall debt levels well, there are still challenges and threats facing regarding the ability and willingness of the Chinese government to follow the US example of a nation-wide bail out of all the banks and finance companies, which resulted in the eventual backlash from the US taxpayers over excessive pay and compensation for most of the CEOs heading those bailed out firms during the aftermath of the crisis, and the criticism by certain factions of the US Congress over the level of accountability from the various government agencies that participated in the bailout . This is a true moral hazard that I believe that the Chinese government and the PBOC officials will not want to take on the role as a lender of last resort, and follow the path taken by the US government during the crisis. There are consequences regarding transparency and openness if the Chinese government were to cover up its debt issues, as the need to instil investor confidence is vital in any financial system.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc