China's debt woes : not yet a "Lehman Moment"

I. INTRODUCTIONAccording to a 15 June 2014 report by the rating agency Standard & Poor's (S&P), China has reached an ominous milestone.1 The country's $14.2 trillion corporate sector debt (or debt owed by non-financial companies) is the highest in the world, exceeding even the world's biggest debtor, the United States which has an estimated $13.1 trillion in corporate obligations.2 S&P estimates that if the current pattern holds, China's debt and refinancing needs will reach $20.4 trillion in 2018 - or one-third of the total worldwide corporate borrowing (Table 1). More troubling, S&P estimates that anywhere between one-quarter to one-third of China's corporate debt comes from the country's "shadow banking sector" - a complex and sprawling network of nonbank lenders that serves borrowers who otherwise would have difficulty accessing credit.3 According to S&P estimates, the debt of China's shadow banking sector is between $4 trillion to $5 trillion. This suggests that roughly 10 percent of global corporate debt is exposed to the risk of a contraction.However, corporate debt makes up just one component of China's debt - albeit, it is the largest component. A sovereign's "total debt" includes government debt, the debt of its financial institutions, non-financial businesses and households. According to the Chinese Academy of Social Sciences (CASS), China's total debt stood at RMB 111.6 trillion (about $18.5 trillion) at the end of 2012 - or 215.7 percent of that year's GDP. Of this amount, corporate debt totaled 58.76 trillion yuan which equaled 113 percent of the country's GDP in 2012, government (including local government4) debt totaled 27.7 trillion yuan or 53 percent of GDP, the household sector debt totaled 16.1 trillion yuan and bonds issued by the financial sector totaled 9.13 trillion yuan.5Yet, these figures are probably on the conservative side because calculations of debt ratios can vary widely depending on types of credit included. And in the case of China, "government debt" does not always include the debt owed by the state-owned enterprises (SOEs), the state-owned banks, and the various special purpose asset-management companies, including the "local government financing vehicles" or LGFVs (which are commercial "window" companies set up by local governments to access credit) which hold large volumes of nonperforming loans. Not surprisingly, Standard Chartered estimates that as of March 2014, China's total debt stood around 142 trillion yuan ($22.7 trillion), or 245 percent of GDP - a sharp increase from about 150 percent in 2008.6 However, according to Standard Chartered, by June 2014, China's total debt-to-gross domestic product ratio had reached 251 - a sharp increase from 147 percent at the end of 2008.7II. CHINA'S GROWING DEBT WOESIn order to blunt the adverse impact of the external shock triggered by the global financial crisis of 2008, in particular, the sharp fall in export demand from the advanced economies, Beijing implemented a massive stimulus program ostensibly designed to structurally shift or "rebalance" the Chinese economy from its export-driven growth path to one led by investment spending. Specifically, in early 2008, Beijing put in place a massive RMB 4 trillion (about US$600 billion) stimulus package to boost the nation's economy. The central government's total funding was around RMB 1.18 trillion with the rest funded by the local governments via the LGFVs. Monetary policy also played a key role in supporting the stimulus program. To this effect, the country central bank, the People's Bank of China (PB°C) cut the policy rate four times from 7.5 percent in August 2008 to 5.3 percent in December 2008, and maintained the rate through September 2010. Moreover, the PB°C lowered the required reserve ratio on RMB deposits from 17.5 percent in August 2008 to 13.5 percent in December 2008, including relaxing bank loan quotas and lifting broad money (M2) growth targets till end-2010. …