SHANGHAI (Reuters) – China must act quickly to address mounting corporate debt, a major source of worry about the world’s second-largest economy, a senior International Monetary Fund (IMF) official said on Saturday.

David Lipton, first deputy managing director of the IMF, warned in a speech to a group of economists in the southern city of Shenzhen that companies’ indebtedness is a “key fault line in the Chinese economy”.

“Company debt problems today can become systemic debt problems tomorrow. Systemic debt problems can lead to much lower economic growth, or a banking crisis. Or both,” Lipton said, according to a copy of his prepared remarks provided to Reuters.

IMF First Deputy Managing Director David Lipton is seen past an IMF flag during a news conference at Article IV Consultation talks in Tokyo May 30, 2014. REUTERS/Issei Kato
IMF’s First Deputy Managing Director David Lipton. REUTERS/Issei Kato

China, whose economy grew in 2015 at its slowest pace in a quarter of a century, has been grappling with rising debt levels and overcapacity.

Last week, the People’s Bank of China warned in its mid-year work report that the government’s push to reduce debt levels and overcapacity could increase bond default risks and make it more difficult for companies to raise funds.

Lipton said corporate debt in China stands at about 145 percent of gross domestic product, a high ratio. He singled out state-owned enterprises, which he said accounted for about 55 percent of corporate debt but only 22 percent of economic output, according to IMF estimates.

Referring to other countries’ experience, he said that China needed to deal with both creditors and debtors and to address governance problems in both the corporate and banking sectors.

“The lesson that China needs to internalize if it is to avoid a repeating cycle of credit growth, indebtedness, and corporate restructuring, is to improve corporate governance,” he said.

(Reporting By Alexandra Harney; Editing by Muralikumar Anantharaman)

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