The Trap of the Chinese Debt Bubble

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China has established itself as one of the world’s premier superpowers through technological innovation, rapid infrastructure growth and substantial economic developments for the better part of the past 3 decades. The People’s Republic has also asserted their dominance in a geo-political manner by becoming a large lender as part of bilateral trade relations with struggling Asian and African nations which are at high risk of defaulting on loans thus regarding this practice as “debt-trap” diplomacy. However, China is in a trap of its own which can bring the global economy into crisis.

Following the global financial crisis in 2008; state-owned financial institutions in the mainland began to lend out large sums of money to developers and corporations to primarily finance infrastructure development and construction projects which would, in turn, stimulate and grow the economy as it provided local jobs, trade and local governments with revenue. Despite figures of measure regarding economic growth and prosperity, a problem which arose from this was “ghost towns”. This new phenomenon has been becoming more prevalent as regional governments strive to meet growth rates outlined by their parties which results in large loans of billions of dollars to generate economic activity becoming a large part of “value” and GDP.

China has had increasing urbanization rates which in 2017 supported by almost 21 million new urban civilians pushing the urbanization rate of the Republic to almost 60%. Moreover, there are almost 65 million vacant units in the country; this, however, is not the main issue. The primary concern is vacant units which are financed by growing debt to support economic prosperity collectively undermining the financial institutions and posing risks to de-stabilizing the global economy.

Much of China’s debt is divided between private entities and those of the state. Corporations in China have the highest debt to GDP% in the world. While China does have substantial amounts of debt, it’s not too far from those developed nations such as the US and UK; however, the difference between these nations is the fact that the US & UK’s GDP/Capita is almost 4x greater than that of China. In addition to the USD and Pound Sterling being backed currencies with stability. In 2008, the Republic’s debt as a % of their GDP was at 141% whereby mid-2017 this figure has ballooned to almost 280%. Nations which have piled on massive amounts of debt often have a recession and economic regression.

China’s almost $40 Trillion of debt is concerning since China is one of the largest trading markets leading the charge in corporate bonds and being the second largest economy; many other nations are dependent and have economies intertwined with China. Nations such as South Korea and Taiwan have as much as 15% of their GDP and economic activity dependent on China in terms of trade relations and exports.

Another issue in this looming debt crisis regarding lending practices is China’s shadow banking. Which is not uncommon in global practice; however the percentage’s at which lending occurs in this unregulated market is staggered in China as the defaults of corporations and inability to keep up with loan and interest payments is becoming problematic and creating issues for the government in Beijing.

   Though the government has created agencies and more stringent policies to combat shadow banking; the private sector is showing signs of weakness and inability to stay up-to-date with payments. Though the country has had a stable interest rate; any sudden increase may prove to be too much and cause a cycle of defaults on loans and payments which could, in turn, create a fallout affect requiring a government bailout for the “bad debts”.

   Chinese corporations hold almost $20 Trillion in debt and as a countermeasure introduced bonds to help pay back their loans. By the end of Q1 in 2017, 9 companies defaulted on bonds issued. As Beijing tries to sustain and limit future credit based growth; this may result in a greater number of entities being unable to make bond, loan and interest payments. An effect this has on the global economy for investors and stakeholders is on the financial markets.

    In March of 2017, on the Hong Kong Stock Exchange, Huishan Dairy was unable to make a loan payment; within a month the company lost almost $5 Billion of market capitalization proving worrisome for investors. This is very concerning as China has risen to become the world second largest economy and third largest bond market.

    If a crisis is to occur; there will inevitably be a catalyst. The first catalyst can be interest rates. Just as things are; corporations including state-sponsored entities are defaulting on loans and bonds. Any increase in interest rates which many countries around the world have done to combat inflation can prove to be problematic with the looming debt in China. Additionally, since for almost 3 decades, the nation has averaged near double-digit GDP growth; it has been able to keep up with debt payments. However with new de-leveraging policies to decrease and contain debt, if the country is not able to maintain economic growth, this slowdown makes it materially harder for the economy to keep up with debt obligations and payments.

    Overall, this is still a building issue and with a government driven by objective and meeting performance metrics. It will be interesting to see what unfolds in coming years; a global crisis or continued growth from this developing nation. It is unclear and difficult to foresee what may happen however if a crisis is looming; it can prove to be catastrophic.