Commentary on Political Economy

Saturday 8 April 2023



An eye-catching new estimate of China’s government debt—now greater than the size of its economy, according to Goldman Sachs—is focusing attention on an issue that’s been overshadowed by the pandemic and China’s property slump.

Using a broad definition that adds official government borrowing along with debt run up by so-called local government financing vehicles and state policy banks, Goldman analysts calculated that the public burden has surged 10-fold over a decade. It reached 156 trillion yuan ($23 trillion) last year, or 126% of GDP, they said.

Among Chinese economists, the debate about debt is growing increasingly fiery, even featuring comparisons to opium addiction and warnings of near-apocalyptic risk. But beyond the rhetoric, there appears to be some consensus.

First, a rapid cut in debt levels would be unwise. Second, government debt measured against assets matters more than the debt-to-GDP ratio. And that means there’s an urgent need to stabilize house prices, a key asset, and to channel investments into endeavors with higher returns.

Residential buildings under construction at Tahoe Group Co.’s Cathay Courtyard development in Shanghai Photographer: Qilai Shen/Bloomberg

This week in the New Economy

Government debt is the largest single chunk of total debt in China, which rose to 284% of GDP last year, according to the IMF. Borrowing has risen fastest at the local government level, and companies created by local governments to raise debt are currently the biggest default concern, alongside privately owned real estate companies.

In 2017, under China’s former economy czar, Liu He, the watchword became “deleveraging” —which in practice meant slowing credit growth to stabilize the debt-to-GDP ratio. That was understandably abandoned during the first years of pandemic. Liu was recently replaced, and the stance of his successor He Lifeng, remains unclear.

Zhao Yanqing, a former government official and economist at Xiamen University, turned up the temperature in February, describing a contraction in leverage as “the real and imminent danger” to China’s economy—even bigger than Washington’s sanctions on semiconductors or decoupling of supply chains.

Zhao highlighted a “debt deflation” mechanism, where attempts to pay down debt cause a reduction in economic demand and therefore output.

To use an example from China’s real estate market, households have taken advantage of savings piled up during the pandemic to pay off their mortgage debt. That lowered their financial liabilities, but meant less cash spent on consumer goods and services, lowering demand in the economy.

Domestic demand won’t recover unless debt grows, Zhao argues. This year “is likely to be the last chance to avoid this crisis. If you hesitate for a moment, the achievements of China's reform and opening up will be wiped out overnight,” he warned.

The use of real estate as loan collateral is the key mechanism behind debt issuance, Zhao writes. Weak demand for and excess supply of housing threatens to lower home prices, putting corporate balance sheets, and so their ability to borrow, under threat.

The top priority for real estate policy is boosting demand and cutting supply to stabilize prices, Zhao argues.

Among his suggestions: a three-year moratorium on debt repayments for troubled borrowers, and a block on borrowers from paying off debt ahead of schedule to ensure that banks’ assets don’t contract. He also urges a national campaign to find investment projects that can generate returns: “Only debt that can create cash flow can truly achieve balance-sheet expansion.”

Zhao Jian, an economist affiliated with the China Economists 50 Forum, founded by Liu He, makes a similar argument about the importance of debt being backed by valuable assets.

Local governments have for years been unable to pay off  borrowing with cash flows from the underlying investments. The “Ponzi” debt they’ve run up is like “opium,” argues Zhao Jian (who’s unrelated to Xiamen’s Zhao). The national government could absorb local liabilities, but that would risk excessive inflation, he writes.

Instead he suggests steps including equity financing by borrowers to reduce their leverage, and better use of data on would-be borrowers by lenders. And he agrees with Zhao Yanqing that China’s real estate prices need to be stabilized to avoid a credit-growth collapse.

Meantime, Peng Bo, an economist affiliated with China’s Ministry of Commerce, argues that Beijing doesn’t need to panic about debt, which isn’t opium, but “necessary irrigation” of the economy, he says. Central banks should backstop against local governments defaulting, but be selective to limit wasteful borrowing, Peng recommends.

How Beijing manages the thorny issue of debt will be key to economic growth in years to come. If these economists are listened too, don’t expect a return to deleveraging any time soon. Tom Hancock

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