China’s debt has surged in recent years. Can it handle it?
China’s great leap forward economically has now led the communist nation to join its developed rivals in the major debtors club. With growth slowing, is the world’s second-biggest economy heading for a crash?
According to a new report by the McKinsey Global Institute (MGI), China’s debt has quadrupled from $7 trillion in 2007 to $28 trillion as of mid-2014, reaching 282 percent of gross domestic product (GDP) and higher than the level of the United States. Continuing its current pace of growth would see China’s debt reach 400 percent of GDP by 2018, the equivalent of Spain.
Commenting on China’s debt explosion, the report said: “Several factors are worrisome: half of loans are linked directly or indirectly to China’s real estate market, unregulated shadow banking accounts for nearly half of new lending, and the debt of many local governments is likely unsustainable.”
According to MGI, property prices have risen by 60 percent since 2008 in 40 Chinese cities, with residential prices in prime locations in Shanghai now only about 10 percent below the level of New York and Paris. A sustained slowdown would hit the housing construction sector that accounts for 15 percent of GDP, while banks would suffer the fallout, particularly city commercial banks where real estate accounts for up to 30 percent of their loan portfolios.
As much as $9 trillion of debt is directly or indirectly linked to the real estate sector, including most of the loans by the shadow banking sector, with loans of around $6.5 trillion. In addition, slowing property markets increase the risk of a blowout in local government debt, with up to 40 percent of debt servicing and repayments funded by land sales.
Borrowing by local governments has grown by 27 percent a year since 2007 – 2.5 times as fast as the central government’s. According to a Standard & Poor’s report issued in November 2014, as many as half of the provincial governments would fall below investment grade, with most having debt to revenue ratios exceeding 100 percent.
Already, a property correction is underway with a 14 percent fall in the value of residential property transactions in 40 Chinese cities between April 2013 and August 2014, although Beijing saw a steep 33 percent dive and Shanghai dropped 21 percent.
MGI said the Chinese economy accounted for more than one-third of global growth in debt since 2007, with the largest driver being borrowing by non-financial corporations, including property developers. At 125 percent of GDP, China has one of the highest levels of corporate debt in the world, it said, noting that “rapid growth in debt has often been followed by financial crises.”
“A plausible concern is that the combination of an overextended property sector and unsustainable finances of local governments could result in a wave of loan defaults in China, damaging the regular banking system and potentially creating a wave of losses for investors and companies that have put money into shadow banking vehicles,” it said.
While spillovers to the global economy would be reduced due to the fact that China’s capital account is not fully liberalized, any further slowdown in Asia’s biggest economy would hit growth prospects for its regional trading partners.
