China’s Deleveraging Campaign Has Ambivalent Impact on Debt: CASS

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A new report released by the Chinese Academy of Social Sciences (CASS) says that while the country’s ongoing deleveraging campaign has had some success in curbing public and financial sector debt, it has failed to tame borrowing levels t amongst Chinese households and non-financial enterprises, as well as rapid growth in the shadow banking sector.

The “2017 Q1 China Deleveraging Report” (2017年一季度中国去杠杆进程报告) released by CASS’s Center for National Balance Sheet (CNBC) notes that in the first quarter Beijing’s deleveraging campaign saw some initial successes, with central and local governments posting modest declines in their leverage levels

Total government leverage fell from 38.8% as of the end of 2016 to 37.7% by the end of the first quarter for a decline of 1.1 percentage points, with central government leverage falling 0.4 percentage points from 16.1% to 15.7%, and local government leverage falling 0.7 percentage points from 22.7% to 22.0%.

The report further notes that based on the debt levels of depository institutions, it estimates that finance sector leverage fell from 72.4% as of the end of 2016 to 71.2% by the end of the first quarter, while an estimate based on asset levels points to a decline in leverage from 78.1% to 77.3% across the same period, for a fall of approximately 1 percentage point for both sets of figures.

While China’s financial deleveraging campaign has led to tightening of liquidity and rise in interest rates in the short-term, the report says that over the long-term term the removal of superfluous “intermediary links” in the financial sector will be of benefit to reducing funding costs for enterprises in the real economy.

“China’s financial sector deleveraging has only just started, and must still undergo much progress,” said the report, which notes that leverage levels for the financial sectors of advanced economies fell 20 percentage points from 132% to 112% during the seven year period from Q1 2009 to Q3 2016.

While public and financial sector debt has seen slight reductions, the CASS report notes that household and non-financial enterprise debt has continued to rise.

Household leverage rose from 44.8% at the end of 2016 to 46.1% by the end of the first quarter for an increase of 1.3 percentage points, while non-financial enterprise debt increased 2.7 percentage points, rising from 155.1% to 157.7% across the first quarter.

Household loans increased 25% year-on-year, with medium and long-term loans rising by 31%, for its most rapid clip of expansion over the past two years.

Given that government curbs on home loans should have led kept a lid on household leverage in the first quarter, CASS speculates that several factors may have contributed to the increase, including the lagging impact of home loan curbs, the momentum of personal mortgages from the high level of commercial property transactions in the preceding period, as well as a shift in leverage from first and second-tier cities to their smaller third and fourth-tier piers.

The report notes that the state-owned enterprise sector lies at the core of ongoing gains in non-financial enterprise leverage, which is in turn spurring rapid growth in shadow banking.

While corporate debt via conventional lending saw an increase in the first quarter, borrowing by means of the shadow banking sector posted especially rapid expansion, primarily by means of trust loans and undiscounted banker’s acceptances.

According to the report several reasons underlie the increase in non-financial enterprise leverage level, chief amongst them rising optimism about the Chinese economy, making companies more willing to fund productivity expansions by borrowing.

Stronger financial regulation is also bringing more corporate debt to light, while for large swathes of corporate China balance sheet expansion is outpacing GDP growth, leading to a rise in leverage levels.

State-owned enterprise debt accounts for approximately 60% of all corporate debt, with SOE’s finding it easier to obtain loans than their private sector peers (given the strong guidance applied by policymakers to the largely state-owned banking sector), yet harder to initiate bankruptcy procedures.

For this reason China’s top policymakers highlighted SOE deleveraging as a priority of the utmost importance during the recent National Financial Work Conference, alongside the proper disposal of “zombie” enterprises.

According to CASS’s report, the key to curbing the sky-high leverage of Chinese state-owned enterprise sector will lie in the removal of low-efficiency enterprises with lagging capacity that are having trouble repaying their debts, as well as shutting down zombie enterprises in order to release the financial and other productive resources that they currently occupy.

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