New Delhi, Aug 28 — China’s debt has surged over the past ten to fifteen years at perhaps the fastest pace in history, leaving China with one of the highest debt-to-GDP ratios in the world—second only to Japan among the major economies. Such sharp increases in debt make further growth unsustainable, according to an article published by the Carnegie Endowment for International Peace.
The current debt problem is largely the fallout of the way China dealt with its earlier debt crisis in 2000. By the late 1990s, China’s banking system was burdened with enormous quantities of non-performing loans and the Big Four state-owned banks were technically insolvent. Official estimates suggested that roughly 25 to 30 percent of their loan portfolios were non-performing, while many independent analysts, including the World Bank, believed the true figure was closer to 40 or 50 percent banks had got saddled with bad loans, according to the article by Professor Michael Pettis.
Moving bad loans from one balance sheet to another does not eliminate them. It merely changes the way in which the losses will be allocated.
Contrary to widespread perception, Beijing did not primarily ask the government to absorb those losses. Instead, it relied overwhelmingly on financial repression by primarily forcing the burden on the Chinese household sector.
Deposit rates for household savings in banks were kept well below nominal GDP growth and, for extended periods, below inflation itself. Because households constituted the overwhelming majority of net savers, they earned extraordinarily low, and often negative, real returns on their bank deposits. Businesses, state-owned enterprises, and local governments, by contrast, borrowed at artificially low interest rates.
The banking cleanup succeeded because households, largely without realizing it, recapitalized the financial system. This is why the common claim that China resolved its banking crisis at little cost is so misleading.
The article points out that as late as 2000, household consumption still represented 63.9 percent of GDP. Instead of rising thereafter, as many economists expected once China had largely completed its initial phase of industrialization, consumption collapsed. By 2010, it had fallen to just 49.4 percent of GDP, by far the lowest share ever recorded in any major economy.
Household income declined as a share of GDP, and household consumption fell with it. At the same time, businesses and local governments gained access to extraordinarily cheap capital. Investment accelerated even as household purchasing power weakened, the article states.
This collapse in household consumption has led to the current structural imbalance in which the Chinese economy depends on exports to drive growth, This in turn has hit the world economy as the flood of cheap Chinese goods has hurt industries in other countries.
“China once again confronts an enormous debt overhang. If policymakers attempt to resolve today’s debt burden in the same way they resolved the last one—by once again transferring resources from households to producers and governments—they may stabilize the financial system temporarily, but they will also deepen the very structural imbalances that have made China’s adjustment so difficult and contributed to the rapid accumulation of debt over the past fifteen years,” the article concludes.