China’s debt has now become one of the most concerning macroeconomic matters entering 2019. It has been one of the hot topics of debate at the World Economic Forum in Davos this week. China’s $34 trillion worth of public and private debt has become a time-bomb with implications for the global economy. Chinese debt has now ballooned beyond reason, having quadrupled in just seven years. Adding to the problems, economic growth in China has slowed, increasing the chances of this ‘debt bomb’ going off causing global turmoil.
So just how bad is the situation? Total debt relative to national output surged to 253% in mid-2018, from only 140 percent a decade earlier. No emerging economy even comes close to such a debt expansion to that of China’s. Debt on its own isn’t necessarily a problem. However, when it is of this magnitude surrounded in worrying economic circumstances that China has, it would seem almost impossible to avoid an all-out debt crisis.
Most worryingly and what is the mechanism that will cause this debt bomb to detonate is China’s economic slowdown. China’s growth is the lowest it has been since 1990, and speakers at Davos this week generally believe this trend to continue. Weak demand coupled with the world’s worst performing equity market are causing defaults to spring up tirelessly. The spike in defaults has dampened bond sales and pushed up financing margins. This has led to higher refinancing costs for mature bonds as well as a tightening in the shadow banking sector, further constricting fundraising options and raising the risk of defaults further through a vicious spiral. And to add any more potential triggers to China’s debt bomb, there are now serious concerns of capital flight. China’s titan investors will not hesitate to invest overseas if defaults and demand shocks put their savings nest in turmoil. China’s richest with fortunes over $300m or more now totals the entire GDP of the UK. A sudden sour change in China’s economic climate could see the capital flight from this elite as has been seen in the past with Russia and its default-ridden history.
Chinese consumers are no better. They too are drowning in debt. Household debt to GDP has hit 55%, from just 36% five year ago. It is the high end of the emerging markets and is only just lagging behind the 60% benchmark that represents the debt-fuelled consumers of northern Europe and the US. Even a modest interest rate of 5% will create a burden of around 4 trillion yuan on Chinese consumers. Without the consumer China can’t move on to the next chapter of its economic development and ensuring these consumers are not crippled by debt before they even enter into a consumer economy is essential.
China’s government must make up for the lack in demand and provide stimulus. Forecasts suggest a stimulus package of $150 billion for 2019. This will allow a lot of potentially defaulting companies to roll over their debt. Moreover, tax cuts for consumers are another option. But with total tax revenue at 16 trillion yuan, the effects are likely to be small. To really prevent the bomb from detonating, China must make serious changes to its long-term economic policy. So far, they have come off far worse in the trade war with the US. An end to this squabble would be a huge boost both to the consumers of China as well as its equity markets that performed horrendously in the latter part of 2018 and are in desperate need of a bullish resurgence. Widespread liberalising reforms are also desperately needed. This includes stock market reform to ensure individual investors can independently pick stocks that aren’t propped up by Beijing and that companies in poor finance can default with transparency rather than convince investors they have sound liquidity. Ultimately, China must realise it cannot rely on the same economic growth it has enjoyed for the past 30 years in its export-led industrialisation. It must liberalise internally as well as internationally and release its vast potential as a consumer economy to fill its gaping demand gap.