Over the last 30 or more years, there has not been a day that goes by without China critics predicting the economy’s imminent collapse because they believe it is piling up huge debts. Each time they have been proved wrong, from mainstream media such as The New York Times in the 1990s to Nicholas Lardy of the Peterson Institute of International Economics just recently.
The Institute of International Finance (IIF) has estimated that China’s total debt-to-GDP ratio was 299% in 2018, of which government, financial corporations, non-financial enterprises and households accounted for 50%, 70%, 130% and 49% respectively.
But whatever the numbers, China’s debts are smaller than those of the Group of Seven, perhaps with the exception of Germany, which according to Trading Economics stood at around 250% of gross domestic product in 2018. The other members’ ranged from 304% (US) to almost 500% (Japan).
In examining China’s debt numbers, it could even be argued that they might be the very reason its economy has sustained relatively high and stable growth rates of above 6% over the decades.
Putting debt numbers in perspective
Of the 50% government proportion of the debt-to-GDP ratio, more than two-thirds belongs to local governments in the form of loan guarantees, largely on private public partnership (PPP) infrastructure and housing projects. In the PPP projects, private partners would put up capital while local governments pledge land. In the event of payment defaults or the partnership dissolves, the local governments take ownership of the projects.
If that happens, the housing units would either be sold or turned into social housing from which the local governments would either earn a profit or enhance social stability. The roads are tolled, generating revenues to pay off the debts. In short, the assets have economic and social values, and are not a waste of money as the critics claim.
Further, the banks that lent money to the PPPs belong to the local governments. In this regard, local governments are actually protecting themselves and their constituencies.
On non-financial corporate debts, state-owned enterprises (SOEs) account for 80%, according to the IIF, Bloomberg and other organizations that are obsessed with Chinese debts. SOEs borrow from state-owned banks (SOBs), implying the loan arrangement is a “family affair.”
Besides, the loans are issued in yuan, which the government is authorized to print. The yuan is legal tender and accepted as payment of debts and medium of exchange within China. What’s more, the Chinese financial system is the biggest in the world, with more than US$36 trillion in assets and deposits of $26 trillion, according to the China National Bureau of Statistics (CNBS).
Further, in order for the financial system to collapse, all SOEs would have to go bankrupt, a very unlikely scenario.
With regard to financial-corporation debts, they are mostly attributed to shadow banks, consisting of insurance, mortgage and other non-bank businesses. They are subsidiaries of state-owned banks, which use them as vehicles for wealth management programs.
As for household debts, most of them are in mortgages. Unlike in the West, buying a home in China is a “family affair” in that members pitch in to help a young couple with the down payment and paying the mortgage if necessary. In this regard, a housing bubble is very unlikely.
According to the China Banking Regulatory Commission, the first-time buyer must put up a down payment of between 20% and 50%, depending on the region. A second home requires a down payment of 50% or more and is only granted if the first house is fully paid for.
In light of China’s huge population, the demand for homes will only increase, enhancing economic growth. Home construction has large multiplier effects, in that it stimulates the furniture and appliance manufacturing industries. They in turn create demand for textiles, leather, steel and other raw materials.
Further, China seems to have learned from the mistakes of the past, which in some ways is resulting in it better managing its debts than the West.
The Chinese government has made mistakes in managing debts. For example, being overly eager to lend money in the late 1990s resulted in a huge number of non-performing loans (NPLs), estimated at between 25% and 40% of the total. This fiasco forced the government to bail out the country’s four largest banks with $400 billion, according to the State Council, China’s cabinet. Designating investment as an engine of growth culminated in over- or mal-investment in which much capital was wasted.
However, the government seems to have learned a lesson, controlling over-borrowing and lending, as evidenced by the 1.7% NPL ratio, a proportion in line with global trends, according to the International Monetary Fund (IMF).
Equally, if not more, important to note is that the government seems to have mastered the science of debt management, applying deficit financing as a counter-cyclical fiscal policy. For example, the government mounted a huge stimulus package of $580 billion in 2008 to avert the economy’s downward movement attributed to the US-originated financial crisis.
Instead of putting China in serious debt as Western critics claimed, the Chinese economy reversed downward growth from 6.5% in 2008 to 9.2% in 2009, according to IMF figures. Since then, the Chinese economy has tripled in size, from $4.6 trillion in 2008 to $13.6 trillion in 2018, according to the World Bank.
Applying expansionary fiscal and monetary policies is very much evident in the 2019 “Two Sessions,” annual meetings of the National People’s Congress and the Chinese People’s Political Consultative Conference. The government is reducing taxes, further eradicating poverty, building infrastructures, and increasing loans to small and medium-sized businesses amid economic slowdowns due to weak external demand.
These are sound economic policies. Exploiting the huge increasingly affluent domestic market could not only enhance and sustain long-term growth, but may also wean China from depending on markets in the West and Japan. A market of almost 1.4 billion people is bigger than those of Europe, North America and Japan combined, bringing enormous economies of scale. Thus the Chinese economy could very well grow between 6% and 6.5% in the coming years.
It is ironic that it takes a “communist” country, and an Asian one at that, to understand and appreciate Keynesian economics. Applying deficit financing during periods of economic slowdowns is investing in the economy, like enterprises borrowing money from banks to stay in or expand business opportunities. The additional revenues generated would pay off debts, explaining China’s relatively small debt levels.
The borrowed funds were spent on economic and employment-enhancing projects. Infrastructures were pivotal in attracting domestic and foreign investment, making the cliché “to make money, one must build roads” a truism. As mentioned earlier, the assets have values.
The West and Japan, on the other hand, are still struggling to pull themselves out of the economic hole that the financial crisis dug. The US, European Union and Japan are expected by supranational institutions to grow by 2.5%, 1.6% and 0.9% respectively in 2019. Unless the US-China trade war ends, those growth numbers will likely be lower in 2020 and beyond.
Critics should study China and its policies more objectively. Offering “subjective” information and questionable assumptions will not cause the Chinese economy to collapse.