COVID-19 has made China’s debt problem worse – The diplomat
China’s ongoing debt battle continues, as the government attempts to reduce its indebtedness following COVID-19-related budget spending. Guo Shuqing, chairman of the China Banking Regulatory Commission, recently said that high financial leverage could threaten Chinese companies with bankruptcy. Guo noted that China’s debt has climbed 30% since the start of the coronavirus pandemic. Because of these risks, the government’s labor report ranked deleveraging as one of the top five tasks for this year.
High debt levels have posed a continuing challenge to China’s economic health. China has struggled with its debt levels since the 2008-2009 global financial crisis, which hit every major country in the world. China has responded to the crisis by encouraging an increase in infrastructure construction by local governments and state-owned enterprises. Even though President Xi Jinping has called for a deleveraging campaign starting in 2015, high debt levels have continued to hit the public sector, especially recently due to the reorganization of spending to tackle the economic woes of COVID. -19.
While the United States, a central economic power whose dollar serves as the world’s reserve currency, has a high tolerance for debt, China’s high levels of debt have created systemic risks. Even though overall debt declined after 2015, it rose again in 2019, reaching 285% of GDP in the third quarter of 2020. Rapidly growing public and household debt has become of particular concern, although the lion’s share of the outstanding debt is occupied by the State owned enterprise and local government debt.
Household sector debt rose 16.3% in February from 15.2% in January. Public debt rose 15% in February, compared to 15.9% in January. The public debt growth target should be 11.5% by the end of the year.
Non-financial companies are expected to strengthen their balance sheets as the economic recovery continues. Growth in household debt is expected to decline as house prices, and therefore real wealth, continue to decline. This will help reduce the pressures on the debt. The stock of shadow bank debt has declined since its peak in 2017, although the flow increased year-over-year in February. The sector will continue to be closely watched for the increase in debt.
Alternative fundraising channels can provide solutions for companies in debt. For example, the long-awaited stock market reforms should enable more companies to raise funds on the stock market and therefore take on less debt. Such reforms would allow companies to IPO through a registration-based system rather than after a lengthy regulatory review process. Debt financing has not worked well; Corporate bond issuance declined last year as bond defaults of well-known state-owned companies increased.
The real culprit of over-indebtedness is slower growth. The global financial crisis and the COVID-19 pandemic have caused unanticipated economic shocks that have hit demand and production, prompting the government to encourage state-owned enterprises and local governments to borrow in order to fulfill mandates fiscal policy. Much of the spending was on physical or “new” infrastructure. All of this added to the debt stock, and China has not seen a big enough push in new sources of growth to sufficiently address this debt problem.
Beyond these external shocks, China has faced structural growth challenges as it shifts from a labor-intensive manufacturing economy to a skilled manufacturing and service economy. By calling for increased consumption before the transition fully takes place, the government is faced with the problem of growing consumer debt as households borrow excessively to consume more. Income in China is about a sixth of that in the United States, and most households cannot afford to consume as much as American households
Economic structural change is extremely difficult due to the skills and wage gaps. Employers note that many workers lack sufficient skills even when they graduate. New occupations, especially those requiring highly skilled workers, often find themselves short of talent. As a result, China may continue to have difficulty moving to the next level of development and higher growth. This means that the leverage problem may persist in the short to medium term.
Since Chinese local governments and state-owned enterprises are most affected by the fulfillment of government policy mandates, they are likely to struggle with levels of leverage, especially if the government needs more infrastructure or investments in new technologies to stimulate a downturn in the economy. While China has withdrawn its efforts to revive the pandemic for the time being, it is likely that the Asian nation will need to accelerate growth in the near future. We can therefore expect the deleveraging campaign to continue.