After China’s economic growth eased to its slowest pace in over a decade last year, concerns about the country’s future have begun to multiply.
Of particular concern is China’s hidden debt risk, which hints that the Chinese government may be liable for a lot more than its official balance sheet would suggest.
Since 2008, the nation’s government-owned banks have embarked on a lending spree of massive proportions. Much of the credit has been directed toward state-owned enterprises, or SOEs, and local governments, who’ve used it to dabble in property and infrastructure projects, many of which are unlikely to generate the cash flows necessary to repay the debt.
As these and other concerns mount, a growing number of commentators are suggesting that a debt crisis in China may not be far off.
China has debt problems? Really?
At first glance, the suggestion that China could be engulfed by a debt crisis seems counterintuitive, perhaps outright silly. After all, the Chinese are one of our biggest creditors — holding $1.26 trillion in U.S. Treasuries as of January 2013 — and possess the world’s largest foreign exchange reserves.
To understand why China’s debt could quickly get out of control, it’s helpful to understand how its economy has grown over the past few decades. China’s growth model is one driven primarily by government-influenced investment and — to a much lesser extent over recent years — exports of mainly manufactured goods. The third, and weakest, engine of growth is domestic consumption, whose share as a percentage of GDP remains astoundingly low for an economy as large as China’s.
As Professor Michael Pettis has repeatedly warned, countries that have relied on this type of growth model in the past almost always run into the same problems — malinvestment during the boom years and a rapid buildup of debt during the downturn. When the model eventually, and inevitably, runs out of steam, debts tend to rise rapidly and often become unmanageable.
Patrick Chovanec, chief strategist at Silvercrest Asset Management and a former professor at Beijing’s Tsinghua University, explains:
With the lending boom that took place in China in the last three or four years, it was fiscal spending in disguise, and now the bill is coming due. Once the fiscal taps are open, the money released will go to pay for the growth of the past four years, not the next quarter, not the next year, not the next decade. You start to see that already, with the bailouts starting to take place in China — local governments, even the national government, devoting resources to bailing out property developers, bailing out state-owned enterprises, bailing out companies that have run into trouble, bailing out local governments.
In other words, China’s attempt to supercharge its growth after 2008 through a massive government stimulus package, though arguably successful at first glance, also led to a rapid buildup of debt among Chinese corporations, local governments, and other entities.