China’s debt time bomb – the fall out

[atatwolf]

If there was a financial crisis in China, the government could take a big hit, transferring a huge chunk of bad debts onto its balance sheet. But this remedy would have a big impact on the domestic and global economy.

Overall debt (public, private and financial) has skyrocketed in recent years, rising from 176 per cent of GDP in 2007, to 258 per cent of GDP by mid-2014. The debt binge may be fuelling a time bomb in the property market.


Source: Oxford Economics

But so far, public debt has remained moderate by international standards. It is around 45 per cent of GDP if you include local and central government direct liabilities (see chart). The figure goes up to around 55 per cent of GDP if you factor in off-balance sheet liabilities, including via local government financing vehicles (as the International Monetary Fund has done).

Bailout costsThe size of bailout costs in the event of a financial crisis would depend upon three main issues regarding exposures of both banks and shadow banks: (1) How big are they? (2) How bad would loans get? (3) Which institutions will be allowed to fail? We take the issues in reverse order.


Issue 1: Who can be allowed to fail?We assume the state bails out all banks and local government liabilities, given concerns over contagion.


Some shadow banking activities have been allowed to fail, in particular risky Trust products. But in our calibration, two thirds will be bailed out again due to financial contagion risks and implicit guarantees.

Issue 2: Bad debts shoot up, reaching over 20% of total loans in the case of banks.Non-performing loans (NPLs) would be set to rise dramatically from current recorded levels of under 2 per cent of total loans. In a crisis scenario, they could reach over 20 per cent.


We are guided by several pieces of evidence.

First, following rapid credit expansion in the mid-1990s, China’s NPLs topped 30 per cent of the total in 1999. Some re-emergence in the relationship is to be expected, given the credit boom.

Second, equity prices of the four largest lenders have plummeted to just 70 per cent to 90 per cent of their book value. And these are widely perceived to be healthier than the smaller, regional banks.

Third, the international experience suggests China’s current combination of massive credit expansion and low NPLs is such an outlier that it cannot last. The chart below shows peak NPL levels in selected crises since 1980.


Source: Oxford Economics



The main damage will come from banks’ loans to corporates. Household lending is less risky, while much of the exposure to other financial institutions– while risky – is underpinned by the likely bailouts.

Asset deterioration in the risky shadow banking products could be more severe, reaching around 30 per cent of total exposures. Lending activities of trust products in particular are concentrated in risky areas such as real estate. But the fallout in our scenario is dampened by our assumption that all exposures to local government financing vehicles are backstopped by the state.

Issue 3: regarding size, bank lending to corporates dominatesAt well over 100 per cent of GDP, the scale of bank loans to corporates is much higher than all other lending.


In spite of all the furore, the risky shadow banking activities of Trust and Wealth management products are much smaller, with exposures to non-government still only 35 per cent of GDP.

Putting all of the costs together, we estimate that a capital injection of 25 per cent of GDP would accrue to the government in our crisis scenario n (see table below).


Source: Oxford Economics

Such costs would not quite get China into the top 10 of bailout costs relative to GDP seen in the last 30 years; Indonesia (1997-01) tops the list with fiscal costs reaching 57 per cent of GDP.

Other debt dynamicsEven aside from financial sector bailout costs, over a three-year crisis horizon unfavourable debt dynamics could add a further 24 per cent to the debt-to-GDP ratio.



Source: Oxford Economics

Under a plausible China-crisis scenario, public debt increases by an average of 8 per cent a year during a three-year financial crisis as the fiscal deficit comes under pressure and growth slumps.

ConclusionsSumming up, we have calibrated a near-50 per cent of GDP increase in government debt following a three year financial crisis. This includes recapitalisation costs and other fiscal dynamics.


This would imply a debt-to-GDP ratio of around 95 per cent. Add another 10 per cent of GDP if you prefer the IMF augmented debt estimates.

That would leave China with a very high debt ratio compared to other EM. However, it would still be lower than the likes of Lebanon and Jamaica, not to mention numerous advanced economies.

Financing the substantial increase in government debt could in principle be achieved via issuance of more government bonds. For example, there would be a ready market from Chinese banks, particularly state-owned ones.

But with debt over 90 per cent of GDP, the scope for further government-sponsored credit expansion would become limited, further re-enforcing our view that Chinese long-term growth could disappoint.


http://blogs.ft.com/beyond-brics/2014/12/02/guest-post-chinas-debt-time-bomb-the-fall-out/

 

[Galad]

Ah another artcle "made in West " - China is doomed .Not gonna happen.China has been around for thousands of years much longer than so-called developed countries with their ever increasing debt,unemployment,social unrest,unfunded liabilities etc.And will be still up and standing for long long time.Now wonder if ever FT will start showing same "concerns" for good old USA(18 trillions + USD already ,debt to GDP over 100%) or UK (debt over 1,4 trillion pounds,close to 80% ratio debt/GDP) or Japan(over 10 trillions USD with 227% debt to GDP ratio) or any other debt-ridden "democracy" in the West.

 

[walle990]

wishful thinking, public debt is the only concern. Ie the central government's debt, the USA has over 100% Debt to GDP on public debt alone. Much worse financial situation than China.


There's a reason why this was posted on a blog and with no author, if it was an article it will be laughed at.

 

[BoQ77]

It's the same issue Vietnam suffering. It's dangerous too.
Too many corruption, and bad debts from real estates ... and so on.

 

[Beast]

wishful thinking, public debt is the only concern. Ie the central government's debt, the USA has over 100% Debt to GDP on public debt alone. Much worse financial situation than China.


There's a reason why this was posted on a blog and with no author, if it was an article it will be laughed at.

Looks like the OP is desperate to prove something which he wants to believe but reality is different

 

[Vassnti]

Yes i know there have been OMG the sky is falling articles about China for as long as i have been here yep they were wrong but there is one thing happening atm that makes me think this time they might not be.

Australia has been the supplier for the China boom Aussie coal Aussie iron ore you name it Australia provided the raw materials China made the goods and the Aussies got a free ride so to speak. China has stopped buying, the Australian dollar has tanked from 1.1 US to 0.8 and may fall further. The Australian economy may be sliding into rescesion.

It still doesnt mean the sky is falling but it does imply things are no where near as rosy as they were or as some think.

 

[AgentOrange]

Yes i know there have been OMG the sky is falling articles about China for as long as i have been here yep they were wrong but there is one thing happening atm that makes me think this time they might not be.

Australia has been the supplier for the China boom Aussie coal Aussie iron ore you name it Australia provided the raw materials China made the goods and the Aussies got a free ride so to speak. China has stopped buying, the Australian dollar has tanked from 1.1 US to 0.8 and may fall further. The Australian economy may be sliding into rescesion.

It still doesnt mean the sky is falling but it does imply things are no where near as rosy as they were or as some think.

China is trying to shift to a more sustainable model of economic development so that means less focus on manufacturing and building infrastructure for the sake of infrastructure. Australia's coal/iron/natural gas boom based on exports to China was never sustainable because China constantly building roads, etc isn't sustainable nor is it wanted.

 

[Chinese-Dragon]

List of countries by public debt - Wikipedia, the free encyclopedia

We have one of the lowest public debt levels in the world.

Not to mention we have around $4 trillion in currency reserves alone. How many times more than your GDP is that, @atatwolf?

Hint: Turkey's entire GDP is only around $800 billion.

 

[SvenSvensonov]

List of countries by public debt - Wikipedia, the free encyclopedia

We have one of the lowest public debt levels in the world.

Not to mention we have around $4 trillion in currency reserves alone. How many times more than your GDP is that, @atatwolf?

That graphic is from 2007 - I've seen it a lot here on PDF, it's outdated!!! The overall public debt remains small, at about 22.4% of GDP in 2013, and this was a drop from 26.1% in 2012.

China Public debt - Economy

If we include all factors, then China overall debt stands greater then 250% of GDP.

Chinese debt: The great hole of China | The Economist - still not cause for alarm though, as this article highlights.

*Post edited, that graphic is actually from 2007, not 2009 and was taken from the CIA Factbook of that year..

 

[Chinese-Dragon]

That graphic is from 2009 - I've seen it a lot here on PDF, it's outdated!!! The overall public debt remains small, at about 22.4% of GDP in 2013, and this was a drop from 26.1% in 2012.

China Public debt - Economy

Well again we established that China has a low level of public debt, compared to other countries.

And not to mention, we have over $4 trillion in currency reserves.

 

[AgentOrange]

That graphic is from 2007 - I've seen it a lot here on PDF, it's outdated!!! The overall public debt remains small, at about 22.4% of GDP in 2013, and this was a drop from 26.1% in 2012.

China Public debt - Economy

If we include all factors, then China overall debt stands greater then 250% of GDP.

Chinese debt: The great hole of China | The Economist - still not cause for alarm though, as this article highlights.

*Post edited, that graphic is actually from 2007, not 2009 and was taken from the CIA Factbook of that year..

Where are you getting 250% from? According to that first link of yours, it's around 44%. Just throwing around 250% "from all factors" without a comparative list of other nations' debts "from all factors" is rather meaningless.

 

[Chinese-Dragon]

Chinese debt: The great hole of China | The Economist

Quote from that article:

"Even if a huge swathe of loans go bad, the consequence is unlikely to be a Lehman-style financial collapse. For that, thank the Chinese regime’s vice-like grip on its financial system. Most lending is by state-controlled banks, much of it to state-owned companies. If it faced an economy-wide credit crunch, the government would (as it has in the past) simply order banks to lend more. At the same time the country’s vast foreign-exchange reserves mean China need not worry about a sudden drying up of foreign capital, the main cause of many other emerging-economy crises."

 

[SvenSvensonov]

Where are you getting 250% from? According to that first link of yours, it's around 44%.

44%? I'll assume that was a typo since the first link states 24%. As for the 250%, read the second link to answer that question.

Quote from that article:

Did you miss that part where I said the debt to GDP ratio was nothing to worry about? Or did you assume I didn't read the article I posted.

What I say following the second link, "still not cause for alarm though, as this article highlights"

 

[AgentOrange]

44%? I'll assume that was a typo since the first link states 24%. As for the 250%, read the second link to answer that question.

Ah, I've read all the allotted economist articles for the month and I refuse to pay for a subscription since I figure my impulse economist buys at the airport for 7-9 bucks a pop is enough already.

Edit: I was looking at the public debt rank chart from that first link. China was at 43.5%.

 

[black-hawk_101]

If there was a financial crisis in China, the government could take a big hit, transferring a huge chunk of bad debts onto its balance sheet. But this remedy would have a big impact on the domestic and global economy.

Overall debt (public, private and financial) has skyrocketed in recent years, rising from 176 per cent of GDP in 2007, to 258 per cent of GDP by mid-2014. The debt binge may be fuelling a time bomb in the property market.


Source: Oxford Economics

But so far, public debt has remained moderate by international standards. It is around 45 per cent of GDP if you include local and central government direct liabilities (see chart). The figure goes up to around 55 per cent of GDP if you factor in off-balance sheet liabilities, including via local government financing vehicles (as the International Monetary Fund has done).

Bailout costsThe size of bailout costs in the event of a financial crisis would depend upon three main issues regarding exposures of both banks and shadow banks: (1) How big are they? (2) How bad would loans get? (3) Which institutions will be allowed to fail? We take the issues in reverse order.


Issue 1: Who can be allowed to fail?We assume the state bails out all banks and local government liabilities, given concerns over contagion.


Some shadow banking activities have been allowed to fail, in particular risky Trust products. But in our calibration, two thirds will be bailed out again due to financial contagion risks and implicit guarantees.

Issue 2: Bad debts shoot up, reaching over 20% of total loans in the case of banks.Non-performing loans (NPLs) would be set to rise dramatically from current recorded levels of under 2 per cent of total loans. In a crisis scenario, they could reach over 20 per cent.


We are guided by several pieces of evidence.

First, following rapid credit expansion in the mid-1990s, China’s NPLs topped 30 per cent of the total in 1999. Some re-emergence in the relationship is to be expected, given the credit boom.

Second, equity prices of the four largest lenders have plummeted to just 70 per cent to 90 per cent of their book value. And these are widely perceived to be healthier than the smaller, regional banks.

Third, the international experience suggests China’s current combination of massive credit expansion and low NPLs is such an outlier that it cannot last. The chart below shows peak NPL levels in selected crises since 1980.


Source: Oxford Economics



The main damage will come from banks’ loans to corporates. Household lending is less risky, while much of the exposure to other financial institutions– while risky – is underpinned by the likely bailouts.

Asset deterioration in the risky shadow banking products could be more severe, reaching around 30 per cent of total exposures. Lending activities of trust products in particular are concentrated in risky areas such as real estate. But the fallout in our scenario is dampened by our assumption that all exposures to local government financing vehicles are backstopped by the state.

Issue 3: regarding size, bank lending to corporates dominatesAt well over 100 per cent of GDP, the scale of bank loans to corporates is much higher than all other lending.


In spite of all the furore, the risky shadow banking activities of Trust and Wealth management products are much smaller, with exposures to non-government still only 35 per cent of GDP.

Putting all of the costs together, we estimate that a capital injection of 25 per cent of GDP would accrue to the government in our crisis scenario n (see table below).


Source: Oxford Economics

Such costs would not quite get China into the top 10 of bailout costs relative to GDP seen in the last 30 years; Indonesia (1997-01) tops the list with fiscal costs reaching 57 per cent of GDP.

Other debt dynamicsEven aside from financial sector bailout costs, over a three-year crisis horizon unfavourable debt dynamics could add a further 24 per cent to the debt-to-GDP ratio.



Source: Oxford Economics

Under a plausible China-crisis scenario, public debt increases by an average of 8 per cent a year during a three-year financial crisis as the fiscal deficit comes under pressure and growth slumps.

ConclusionsSumming up, we have calibrated a near-50 per cent of GDP increase in government debt following a three year financial crisis. This includes recapitalisation costs and other fiscal dynamics.


This would imply a debt-to-GDP ratio of around 95 per cent. Add another 10 per cent of GDP if you prefer the IMF augmented debt estimates.

That would leave China with a very high debt ratio compared to other EM. However, it would still be lower than the likes of Lebanon and Jamaica, not to mention numerous advanced economies.

Financing the substantial increase in government debt could in principle be achieved via issuance of more government bonds. For example, there would be a ready market from Chinese banks, particularly state-owned ones.

But with debt over 90 per cent of GDP, the scope for further government-sponsored credit expansion would become limited, further re-enforcing our view that Chinese long-term growth could disappoint.


http://blogs.ft.com/beyond-brics/2014/12/02/guest-post-chinas-debt-time-bomb-the-fall-out/

So China is in problem?