Should we worry about China’s debt?

China’s Balance Sheet Challenge,

Nicholas Borst, China Leadership Monitor, March 1, 2023

prcleader.org and worldbank.org

We begin with three statements:

1. China is now much more indebted than countries at similar levels of economic development.

2. The slowdown in the economy over the past year has increased pressure on over-leveraged borrowers, and

3. That poses risks for the financial system.

The data.

At the end of 2021 (the most recent data), China’s external debt was US$2.7 trillion, according to the World Bank. There are different kinds of debt, long-term (more than one year) and short term (e.g., trade financing); public and private; and publicly guaranteed or not. And, debt may be measured in stock – all debt, accumulated over time and still unpaid – or just that disbursed during the year in question.

Trends take time to develop, so looking at longer periods can be useful. In this analysis (because of data availability), I will look it the 2019-21 period as it compares to the previous nine years (2010-18). We will also assume that the data is correct, and no different in quality that that of the United States or other developed nations. That’s a very large assumption, but we have nothing better to go on.

The long and short of it.

Long-term debt stock rose 16% per annum over the past decade (2012-21), while short-term obligations increased by 6.5% a year. That reduced the share of short-term debt from an average of 65.5% in 2010-18 to 54.4% in 2019-21. Since short term principal and interest must be paid in full within a year, less short-term debt is generally better than more.

Among the long-term debt, that which the public sector explicitly guarantees decreased from 77.7% in 2010-18 to 72% in the later three years. In other words, the market accepted more risk. The increase in borrowers’ ability to repay their short-term debts was even more dramatic, from 10.1% to 19.6%.

Who’s exposed

The mix of lenders has been evolving as the financial markets have matured. Bondholders increased their exposure to China’s total debt from 12.9% to 26.8% over the periods under review, whereas commercial banks reduced their share of the risk along with the World Bank and other official creditors. More, bondholders picked up almost all of the non-guaranteed risk that commercial banks declined.

Finally, there’s the economy’s ability to repay its debts. Among middle-income economies, the average debt service (all interest and any principal due this year) to exports ratio was 15.4% in 2019-21. For China, it was 9.2%. And, when debt stock is compared to foreign exchange reserves, China’s 136.6% average is nearly double the peer group’s 72.9%.

A final word.

One of the great unknowns in understanding China’s debt situation is the actual risk associated with debt held by quasi-governmental entities. If the worst scenarios began to unfold, it is entirely likely that the political elite would decide to do whatever it takes to ensure that the problem is addressed as quickly and painlessly as possible.

That’s what happened in the United States during various crises, and we shouldn’t expect any less from China. More, we should also remind ourselves that China has a very strong ability to fund its own needs.