Some pundits and media in the West, those in the Anglo-American world in particular, seem to have been obsessed with China’s economic and financial problems, singing the same “doom and gloom” song – the Chinese economy is “drowning in a sea of debt” or a “financial bubble” is unavoidable – for more than 30 years.
The latest exposé is on China’s shadow banks, financial institutions doing banking business but not subject to the regulatory regimes that govern commercial banks. Bloomberg and other financial institutions in the West speculate that shadow banks may have increased their business volume from approximately US$3 trillion in 2014 to more than $8.5 trillion in 2016. This phenomenal rise is said to have been caused by the shadow banks’ aggressive marketing of wealth management, seducing investors with unrealistically high rates of return, as much as 15% annually.
Yet China’s economy and financial system, according to statistics released by the International Monetary Fund and other reputable economic institutions and analysts, are getting bigger and stronger.
Though no one knows (except God, but he is mad at us for our sins) what the future holds, the Chinese economy and financial system will encounter risks. Companies may go bankrupt, a war between the US and China may emerge, and other unforeseen problems could culminate in an economic and/or financial catastrophe. But this scary scenario applies to every country, not just China. For example, who would have predicted the events of September 11, 2001?
On defusing China’s ‘debt bomb’
In fact, however, the Chinese economy may be in a stronger financial situation than those in the Group of Seven. Below are some comparative statistics and information in support of that view.
- China’s 2016 net public debt (central and local) was 20% of gross domestic product, while that in the G7 countries averaged more than 80%, according to the US Central Intelligence Agency. This would suggest China is in a much stronger fiscal position. And growing by more than 6.5% annually, the Chinese economy can generate sufficient revenue to service its debt, whereas the G7 cannot because of its average annual growth rate of less than 2%.
- China’s consumer debt as a proportion of disposable income is less than 40%, compared with the United States’ 110%, Japan’s 135% and the G7’s 114%, according to the World Bank. These statistics explain why China’s consumer spending increases by more than 6% annually compared with the G7 rate of less than 1%.
- China’s external debt (the amount owed by governments, businesses and consumers to foreign nations) is $1.4 trillion, compared the US rate of 18.2%, Japan’s 3.6% and G7 countries average of 6.2%, according to the World Bank, CIA and others. China’s low external debt-to-GDP ratio (12%) would suggest limited capital outflow in the event of loan recalls. But at an external debt-to-GDP ratio of more than 120%, the G7 could encounter massive capital outflows and significant rises in interest rates should that emerge.
Putting Chinese local government and corporate debts in perspective and considering China’s formidable financial toolkit, they are even less worrisome than those in the G7.
Western pundits target Chinese local government and corporate debts as the most worrisome, suggesting they are, respectively, between 100% and 300% of GDP. The debt numbers are questionable because they are little more than “best guesses”. But even assuming they are correct, China’s relatively strong economy and financial system can handle them, for the following reasons.
First, more than 65% of debts are owed by state-owned enterprises (SOEs) to state-owned banks (SOBs), suggesting the government is lending mostly to itself, or that the loans can be rolled over.
Second, unlike the West’s neoliberal system, SOEs and SOBs are set up to “serve the people”. According to this philosophy, sustaining production and employment is more important than earning profits. So even if SOBs and SOEs earn less profit, the value of economic and social stability is “priceless”, to borrow a term from the MasterCard commercial. The Anglo-American profit-maximization posture of focusing on returns to capital is shifting the financial burden to society, raising social costs and persistent high unemployment rates. Both of these are culminating in a surge of populism and protectionism.
Third, China’s investment projects – buildings, factories and infrastructure – have values that are sold for a profit, generate revenues, and spur economic growth. The highway tolls are said to be sufficient to service the debts. The Olympic Village condominiums have earned the state a handsome profit; costing 3,000 yuan ($439) per square meter to build, they sold for 30,000 yuan. The huge housing bubble that some US pundits were certain would result from the large-scale construction of residential dwellings did not occur. On the contrary, they earned local governments and developers huge profits, because China’s people consider buying houses not only a necessity but also a good investment. Last but not least, the huge spending on infrastructure projects was largely responsible for attracting domestic and foreign private investment.
Fourth, local-government debt is actually loan guarantees for private-public-partnership projects in which private developers must put a specified amount of capital upfront. In the event of payment defaults, the local governments would take possession. And as mentioned earlier, the local governments also own the lending banks and the land (leased for 70 and 30 years, respectively, on residential and commercial buildings) on which the assets were built.
Enormous financial toolkit
Further, China’s bank deposits are huge, more than $21 trillion, thanks to the phenomenal savings rate of nearly 50% of GDP or over 25% of disposable income. A big chunk of the deposits are said to be profits from SOEs and state-owned-financial institutions such as insurance companies. Chinese banks are in fact relatively profitable.
The Chinese government learned a lesson in the 1990s when SOBs were allowed to make huge numbers of risky loans, resulting in a non-performing-loan ratio of more than 25% of total lending. After bailing out the four major banks with $400 billion, the government tightened the lending process. Banks now are required to gain approval from the state for loans over a specified amount; maintain a reserve ratio of 17% of deposits; and cap the loan-to-deposit ratio at 75%. These measures culminated in an NPL ratio of 1.7% in 2016, in line with those of G7 nations.
Moreover, the authoritarian government can and impose measures to curb problems before they push the economy to the brink, and has done so. For example, the state immediately stopped trading during the 2015 stock-market crisis and arrested those who were manipulating stock prices.
The assumptions behind China’s debt figures are debatable. First, it is assumed that most if not all Chinese were “suckered” by the shadow banks’ false advertising. Second, for a financial bubble to occur, most if not all borrowing enterprises will default on loan payments. Third, the investment in infrastructure was a waste of money because they were “roads to nowhere”.
In short, the issue of China’s insurmountable debt problem may be “fake news” or at least exaggerations, spread by some pundits over the past 30-plus years. If things were really as bad as Western pundits have alleged, the Chinese economy and financial system would have collapsed by now.
China’s debts, while they are growing, will not threaten the country’s economy or financial system. The G7, however, may not be able to sustain increasing government spending on consumptive items such as pension payments because of slow economic growth.