Niall Ferguson coined the term “Chimerica” to characterise the economic relationship between China and the United States. In his view, China does the saving, and the United States does the spending. This is true to a certain extent but that does not mean that China does not borrow. Today, I want to explore debt in the Chinese economy.
Many people point to the fact that household leverage in China is low, and savings rates are much higher than the United States. They also point out that this is part of the Confucian culture, which encourages savings. Still others point out that social security is weak in China, so people are more likely to save in order to prepare themselves for retirement as well as shocks (Nouriel Roubini has an interesting review on these issues). Because of this, they reason that a US-style of housing market collapse is unlikely.
I largely agree with the last point. The Chinese government has been doing a good job of preventing people from borrowing too much to buy apartments. The down-payment requirement for a first home buyer is 30% of the sale price, higher still for a second home, and it is virtually impossible to get a mortgage for third or fourth homes. Some people, as a result, hold the view that Chinese real estate prices are driven by genuine demand, and the economy is not driven by debt. For them, it is impossible for the real estate market to collapse. Shaun Rein is one example.
However, although it is true that a US-style housing market collapse is unlikely, that does not mean that China has no debt, nor that a correction in its own style isn’t possible. Debt may not be a big household issue, but local governments and various government ministries are leveraged from building mega infrastructure projects. So are real estate developers, who are financially stretched after a spree of land acquisitions in the past two years.
Local governments, for instance, are borrowing large amount of money through the so-called “local government financing vehicles (LGFV)”, which is somewhat similar to an off-balance entity banks used to hide their bad assets before the financial crisis. Victor Shih of Northwesters University put his estimate of these debts at 11.429 trillion yuan, or about 28% of nominal GDP.
In the railways industry, the drive to build the huge high speed rail network also involves large amount of debt financing. The enterprises related to the Ministry of Railways have collectively about 2 trillion yuan of debt (gross) according to a recent disclosure, another 5% of nominal GDP.
The new affordable housing programmes are also financed by bank loans. A team of analysts from Standard Chartered created a great presentation about a recent trip to inner China. Two pages about the public rental housing in Chongqing really caught my attention because of the scale and ambition of the project, as well as the financing of it. In short, the investment will amount to 100 billion yuan, and 70% of that is financed by debt. I have done some more calculations of the financing previously, which I don’t repeat here, except to say that the margin of safety is quite narrow. As the government moves to invest in affordable housing to tackle the problems of high property prices, similar schemes may become common.
These are some of the identifiable debts that are associated with governmental entities. That means that if they cannot service the debt, we can reasonably assume that these debts will become the central government’s debt burden.
There is little transparency for the actual debt the government and government-related entities have, so it might be fair to say that the sum of identifiable debts is at best the lower-bound for the actual debt burden. With other debts (including the debt of policy banks and others), an earlier report from WSJ put the estimate of debt-to-GDP ratio at 59%, while a couple of other people put their estimates at some higher numbers.
Is this sustainable? The short answer is it depends. We do not know the exact amount of debt, which makes this judgment difficult. Also, there has never been any easy rule to gauge where the debt-to-GDP ratio becomes unsustainable. Historically, that “threshold” of debt varies from time to time and from country to country.
The key conclusion for any attempt to look at debt in China is, first of all, there is a lot more than you can identify. And second, this level of debts is sustainable for now, until it isn’t.