Just How Overleveraged is China’s Economy?

Moody’s recent decision to downgrade China’s sovereign credit rating due to concerns over burgeoning debt has prompted some domestic observers to turn the spotlight onto the country’s leverage levels.

After Moody’s Investors Service downgraded China’s credit rating for the first time in three decades, the Ministry of Finance protested that the country’s burgeoning debt levels were well under control.

“In 2016, China’s government debt ratio did not not change significantly compared to the previous year…during the period from 2018 to 2020, China’s government debt risk index will not undergo major changes compared to 2016,” said MOF.

Moody’s decision has become a talking point in the Chinese financial press, with some observers echoing the government’s opinion that claims of excess leverage are overstated.

An editorial recently published by state-owned China Economic Net turns the spotlight on Chinese leverage levels, noting that the figures produced by both domestic and overseas research are largely consistent.

Moody’s cites an Institute of International Finance figure that puts China’s total debt, encompassing government, household and non-financial enterprise debt, at 256% of GDP as of the end of 2016.

Data from the Bank of International Settlements puts China’s total leverage at 255.6% as of the end of the third quarter, while estimates released by the China Academy of Social Sciences are roughly in line with these figures.

China Economic Net notes, however, that these debt levels are well below the average for advanced economies, as well as the figure for most OECD nations.

BIS data indicates that as of the end of Q3 2016 US debt was 255.7% of GDP for the UK it was 283.1%, for France it was 299.9% and for Canada it was 301.1%. Japan stood well ahead of the pack with debt equal to 372.%5 of GDP, while the average for key advanced economies was 279.2%.

BIS research further indicates that year-on-year growth in China’s total debt in Q3 2016 fell 2.5 percentage points compared to the preceding quarter for two successive quarters of easing expansion.

China Economic Net concludes that Chinese debt remain at a moderates level for major economies and is currently tending towards stability, while the country also enjoys greater growth momentum as a developing nation.

“It should be noted that compared to major economies, China’s economic growth remains strong, and this is the foundation for its credit strength,” said Professor Qiao Baoyun of the Central University of Finance and Economics.

Zheng Chunrong, vice head of the Public Policy and Administration Research Institute of the Shanghai University of Finance and Economics, said that the the Moody’s downgrade fails to take into account the particulars of China’s economic circumstances.

“China is currently in the process of urbanisation, and government debt is mainly used for infrastructure development, which is of benefit to reducing enterprise cost and expediting economic growth, ” said Zheng to China Economic Net.

“Although this debt does not generate any direct commercial returns, it nonetheless has very strong social returns. This is a fundamental difference compared to the government debt of some other countries, which is mainly used to resolve standard fiscal spending gaps.”

Zheng said that China’s corporate debt risk remains at a “safe and controllable” level overall, due to productivity gains as well as continual growth in company assets.

Over recent years the central government has placed heavy emphasis upon corporate deleveraging by means of “marketisation and the rule of law,” as well as debt-to-equity swaps, expansion of stock financing, as well as broader supply-side structural reforms.

Industrial enterprise debt levels have edged lower since the start of the year, with the average debt to assets ratio for March 2017 posting a year-on-year decline of 0.7 percentage points to 56.2%.

Qiao Baoyun notes, however, that deleveraging remains a massive challenge for Chinese companies and state-owned enterprises in particular, as well as entail a gradual process involving supply-side structural reforms deployed in tandem with other measures.