Red flags flutter outside the Great Hall of the People before the second plenary session of the Chinese People's Political Consultative Conference (CPPCC) in Beijing, China March 8, 2018. Photo: Reuters/Aly Song
Red flags flutter outside the Great Hall of the People in Beijing on March 8, 2018. Photo: Reuters/Aly Song

The next wave of debt worries to spook global markets will come from Chinese households. The number 18 says it all. That’s how much in percentage terms Fitch Ratings calculates Chinese household debt grew in 2018 alone.

In 2008, meanwhile, the ratio of China’s consumer IOUs to gross domestic product was 18%. By the end of 2018, it had surged to 53%.

That’s well above the roughly 40% average of emerging nations. Equally troubling, in recent years annual increases have nearly doubled inflation-adjusted GDP.

Here’s yet another ominous factoid: housing lending outpaced corporate borrowing last year to become the largest contributor to mainland loan growth.

The kind way to view this trend is that Beijing is indeed succeeding in recalibrating growth engines from smokestack-heavy exports and unproductive investment toward domestic demand. Yet households taking to plastic and other forms of consumerism with such enthusiasm is sparking alarm from Fitch to Standard & Poor’s to even economists at the Federal Reserve.

It’s not only China

As national growth slows, consumers may have less available cash to buy apartments, cars, smartphones, apparel or airline tickets. Add in rising debt burdens, and Beijing will be hard-pressed to power up spending as the trade war slams growth. The 6.2% GDP rate in the first quarter was already the slowest in 27 years.

“Rising household debt may lead to overleveraging by individual borrowers, eventually becoming a headwind for growth as debt service costs rise at the expense of other discretionary spending,” Fitch warns in a recent report.

It’s not only China. Booms in auto and housing demand in Malaysia, Thailand and elsewhere in Asia have driven household debt ratios sharply higher. In Thailand alone, it’s close to 70%. The surge is most pronounced in Asia’s biggest economy.

S&P reckons that unsecured consumer borrowing in China could grow an annualized 20% over the next two years. As economists learned after the 2008 Lehman Brothers crisis, and Asia’s 1997 meltdown, late-cycle loans tend to be the riskiest.

The US subprime debacle was proof enough of that. But so were household-debt-driven reckonings from Hong Kong to South Korea to Taiwan over the last 20 years. China’s trajectory could follow this pattern as households get dangerously overexposed.

China hasn’t formally proven it can avoid the so-called middle-income trap. The reference here is to per capita incomes stalling out around the US$10,000 mark. China is on the cusp of that level in nominal GDP terms.

New tariffs

Beating the trap would be challenge enough, even without Donald Trump’s tariffs. He announced fresh ones on Friday – 10% taxes on another $300 billion of mainland goods.

Chinese exports were essentially flat for the first half of 2019. Factory activity contracted in July. The Caixin/Markit purchasing managers’ index came in at 49.9, below the 50 mark that denotes expansion.

The real fallout, though, is showing up in key trading partners. South Korean exports plunged 11% year-on-year in July. The collateral damage in Japan is equally sobering. The 6.7% decline in overseas shipments from Japan in June was the seventh straight monthly drop.

As Chinese demand wanes, President Xi Jinping is running short on conventional levers to stabilize GDP. Earlier this week, the Communist Party’s top decision-making body pledged to accelerate stimulus efforts.

Perhaps the biggest question is whether Beijing will ease curbs on property markets as a means of boosting construction.

That, however, might exacerbate the buildup in household borrowing. And China’s overcapacity problem, once evidenced by the roughly 65 million apartments that remain unsold around the nation.

More aggressive People’s Bank of China rate cuts could have similar side effects. So far, PBOC Governor Yi Gang has treaded carefully. Now that the Fed in Washington is easing again, though, the PBOC may feel is has room to ease.

Earlier this year, economists at the Fed Bank of New York raised their own red flags about China’s household debt risks. “The impact on growth and consumption dynamics of household debt are complex, but some research suggests that fast increases in household debt entail trade-offs between faster, near-term GDP growth and slower growth in the future,” Fed staffers Hunter Clark and Jeff Dawson argued in a report.

The Fed’s research jibed with a 2017 International Monetary Fund report warning of an “amplified negative impact on the banking sector and the macroeconomy” if consumer debt continues rising apace. Since then, it surely has, increasing China’s risk profile.

In May, Chen Changsheng, a top research official at China’s State Council, raised concerns about Beijing’s worsening “macro leverage ratio,” which he says “is definitely going to rise.”

It was 250.3% of GDP in 2017 before falling 1.5 percentage points in 2018. Yet US President Trump’s trade war has leverage and household debt on the rise again.

That’s not necessarily a problem if China can keep growth north of 6% and per capita incomes rising. Trump’s trade war makes this unlikely. Bottom line, China’s growth trajectory now rests on increasingly weak foundations.

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