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Pay down time

By ZHANG BIN | China Daily Global | Updated: 2024-06-07 10:27
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The Chinese government still has ample policy space to deal with the country's debt problems

The scale of China's debt and its ratio to GDP have increased rapidly over the past decade. According to the Bank for International Settlements, the combined debt of Chinese enterprises, government and households reached 363 trillion yuan ($50.13 trillion) as of 2023, with a debt-to-GDP ratio of 288 percent. Over 98 percent of this debt is from domestic stakeholders, with foreign debt standing at a tiny proportion. It has become a top concern among policymakers and the academia how to view this rapidly rising debt and what response should be rolled out.

Over the past 20 years, the main debtors and the purposes of debt in China have undergone significant changes, a period that can be roughly divided into three stages.

The first stage was from 2004 to 2011, when China was at the peak of its industrialization, characterized by the rapid development of capital-intensive industries such as steel, chemicals, energy and equipment manufacturing. Capital-intensive industrial enterprises were the main debtors during this period, with limited borrowing by the government and households.

The second stage was from 2012 to 2019. After China's industrialization peaked, capital-intensive enterprises no longer borrowed heavily, and local government financing platforms and households became the main sources of new debts. Local government financing platforms mainly borrowed for infrastructure investment, but not primarily for electricity, heating and public transportation projects. Instead, a large amount of the borrowing was invested in urban public facilities such as underground pipelines, urban greening and environmental protection, significantly changing the urban landscape in China. During this period, households also began to borrow a large amount of debt, mainly for home purchases. Some also borrowed for spending purposes.

The third stage has been from 2019 onwards. Under policies to rein in the hidden debts of local governments, the scale of borrowing by local government financing platforms dropped. China has adopted more government special bonds and treasury bonds to replace previous borrowing by local government financing platforms from commercial financial institutions, thus reducing debt interest costs and extending debt maturity structures. Meanwhile, household mortgages have dropped as a result of major changes in China's real estate sector. But China's policymakers have emphasized strongly the importance of creating a more favorable credit environment for small and micro enterprises, green finance and the manufacturing sector, leading to faster credit growth in these sectors in recent years.

The debtors and purposes behind China's debt expansion are roughly the same with high-income countries and regions at the same stage of development. During the peak of their industrialization, the borrowers in well-performing economies such as Germany, Japan and the Republic of Korea were enterprises, particularly industrial enterprises. After the peak of industrialization, the main borrowers shifted to the government and household sectors, with the proportion of government borrowing in total debt also on the rise.

China has not overborrowed from the perspective of its total debt volume. The function of debts is to transform savings into investment, enable consumption smoothing, and create financial assets. All these functions indicate that creating too much debt leads to a lot of investment and consumption, strong purchasing power, and consequently inflation and currency depreciation. However, this has not been the case for China. Over the past decade, China has not faced inflationary pressure. Instead, the nation has been frequently confronted with lackluster demand. China's average annual consumer price index growth rate has been less than 2 percent during the period, and the nominal exchange rate of the yuan against a basket of currencies has appreciated by 15 percent. This indicates that China has not created excessive financial assets and purchasing power. The nation's financial assets are mainly debt-based. China's creation of financial assets relative to GDP is not high considering its total debt-based and equity-based financial assets. The financial assets of the United States, Japan, China, and Germany are 13.4 times, 15.7 times, 3.6 times, and 3.7 times their GDP respectively. Therefore, China's financial assets, relative to GDP, are not prominent.

From a structural perspective, China needs to further optimize its debt structure. The nation's two main borrowers are faced with significant debt pressure. The first major borrower is local government financing platforms. Over the past decade, such platforms have borrowed heavily as they invested in projects such as urban roads and public infrastructure — projects with low commercial investment returns. Many local government financing platform operators are struggling to cover their debt costs with their revenue. The second major borrower is real estate enterprises. Chinese real estate enterprises have high debt ratios, and in recent years, the sharp decline in home sales and the nosedive in financing from financial institutions have left many real estate companies unable to repay their debts.

China has ample policy space to address its structural debt issues. It requires the intervention from macroeconomic regulators and the support from government credit to solve the hidden debts faced by local governments and real estate debt problems. Whether the government can expand credit is not determined by how high the government's existing debt or its debt ratio is, but by the balance between private sector savings and investment. If private sector savings exceed investment, an increase in government borrowing and spending will not lead to inflation or threaten monetary credit, and thus the government can expand credit. If the demand for private sector savings is far outweighed by investment, and the economy is overheated with inflationary pressure, the government should not expand its credit scale, as it would lead to damage to monetary and government credibility. Currently, private sector savings far exceed investment in China, and there is no overheating or inflationary pressure in the nation, which provides ample policy space for the government to expand credit.

It is necessary for China to adopt more proactive measures to expand its debt. The most prominent macroeconomic problem facing China is insufficient demand, leading to low corporate profitability, fewer newly added jobs and weak investor expectations. The most common and effective policy tool to address insufficient demand is counter-cyclical policy, using lower interest rates and increased government borrowing to boost spending, in order to drive credit and spending growth across society. These policy tools are very helpful in reducing debt pressure and mitigating debt risks. International experience and China's past experience show that the reduction of the scale of debt makes it even more difficult for borrowers to repay their debts. This is because reducing the debt scale also greatly reduces income, which would also increase the debt ratio. By reducing the policy interest rate and expanding government spending, the government can reduce debt interest costs and raise income levels. Doing so would also improve the capacity to repay debts, mitigate debt risks, and reduce the debt leverage ratio.

The author is deputy director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. The author contributed this article to China Watch, a think tank powered by China Daily.

The views do not necessarily reflect those of China Daily.

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