VINACHEM

China’s ratio of debt to its economic size is seen climbing for at least another four years, underscoring the risks facing policy makers as they strive to prevent a deeper slowdown without triggering a credit blowout.

Seven out of 12 economists see the debt-to-gross-domestic-product ratio increasing through at least 2019, with four expecting a peak in 2020 or later, according to a Bloomberg News survey. Debt will peak at 283 percent of GDP, according to the median estimate of eight economists.

Policy makers grappling with the fallout from a credit binge after the global financial crisis are also being confronted by anemic demand for exports and an aging workforce, pushing economic growth to the slowest pace in a quarter of a century. With robust consumption and services struggling to pick up the slack from slowing investment and manufacturing, China’s communist leaders are striving to put a floor under growth to ensure average expansion stays around 6.5 percent through 2020.

"We doubt the debt ratio will peak before 2020," said Julian Evans-Pritchard, a China economist at Capital Economics Ltd. in Singapore. "Our model puts the peak in the debt ratio in 2024, but the ratio could rise further beyond that if Chinese policymakers fail to implement the necessary structural reforms required to improve credit allocation."

Concerns over China’s borrowing came to the fore last week, when a report showed the country’s banks extended a record 2.51 trillion yuan ($385 billion) of new loans in January. The increase in debt could pressure the country’s credit rating, Standard & Poor’s said on Tuesday, less than a week after the cost to insure Chinese bonds against default rose to a four-year high.

Underscoring the delicate balancing act between the desire to keep credit flowing, but not too fast, the central bank will boost the amount of reserves that must be locked away by some banks. The move reinforced the view that the central bank is striving to prevent a repeat of the 2009-2010 credit blowout, said Tim Condon, head of Asian research at ING Groep NV in Singapore.

The tightening of liquidity for some lenders follows the monetary authority’s recent announcement that it would adopt a so-called macro prudential assessment system that uses commercial banks’ required-reserve ratios to help enforce financial stability.

Still, the PBOC is seeking to lower overall borrowing costs to underpin an economy that expanded at the slowest pace in a quarter century last year. To guide market interest rates lower, the PBOC last week provided cash through its Medium-term Lending Facility at 2.85 percent for six-month loans, down from 3 percent.

It is almost impossible to identify a specific debt-to-GDP level or time period that will “tip” the Chinese economy into a financial crisis, Goldman Sachs Group Inc.’s investment management division said in a January report. Comparing the magnitude and pace of the increase in China’s debt-to-GDP ratio to those of other countries, it concluded China’s increase is among the highest in recent history.

"Every major country with a rapid increase in debt has experienced either a financial crisis or a prolonged slowdown in GDP growth," wrote analysts led by New York-based chief investment officer Sharmin Mossavar-Rahmani and Hong Kong-based investment strategist Ha Jiming. "History suggests that China will face the same fate."

The paper compared China to five countries that experienced financial crises since 1990 -- Japan, South Korea, Thailand, the U.S. and U.K. -- and found China’s increase in debt relative to GDP since 2008 was exceeded only by Thailand’s binge from 1990 to 1997.

"Most also had lower levels of debt relative to GDP and, again with the exception of Thailand, were far richer than China at the time of their crises," it says.
Fiscal Room

The risk going forward is that China’s growth targets are still too high and lead to higher fiscal deficits and debt, Standard & Poor’s said last week. The nation’s room for fiscal maneuver will shrink when potential problems such as deteriorating asset quality in the banking sector arise.

While China has a high level of corporate debt, government debt isn’t high, said Wang Yiming, deputy director at the Development Research Center of the State Council in a briefing last week. China’s high savings rate is also supportive of higher investment, which may provide a buffer to a higher debt-to-GDP ratio, said Tommy Xie, an economist with Oversea-Chinese Banking Corp. in Singapore.

At the higher end of the spectrum, respondents Evans-Pritchard and Larry Hu, head of China economics at Macquarie Securities Ltd. in Hong Kong, see China’s debt-to-GDP ratio peaking at about 300 percent of GDP. At the lower end, Nie Wen, a Shanghai-based economist at Huabao Trust, estimates it will peak at 250 percent.

"If China chooses the zombie bank/company mop up and prop up strategy, they will slow not only productivity but current and potential GDP," said Constance Hunter, chief economist at KPMG LLP in New York. "If they choose instead to take the heretofore unrecognized bad debts of the state-owned banks on the government balance sheet, a la Ireland, they will increase government debt but they won’t have zombie banks and they are more likely to see a robust recovery."