China debt stress indicator at record high

Posted on September 19, 2016

General Economy Images As Citic Sees PBOC Staying Out of Market to Curb Debt...A man walks on an overpass in the Luohu district of Shenzhen, China, on Thursday, Dec. 19, 2013. Two of China’s three biggest securities firms predict the central bank will refrain from using open-market operations to inject funds this week as policy makers seek to rein in debt and contain inflation. Photographer: Brent Lewin/Bloomberg©Bloomberg

China’s lending frenzy has seen the country notch up a record debt benchmark that takes it to three times the typical danger level, according to new data from the Bank for International Settlements, underlining what could be one of the biggest risks to the global economy.

The government and the private sector have borrowed heavily to fuel economic growth and keep people in jobs — but at the cost of a rapidly rising debt pile that hit 255 per cent of gross domestic product at the end of March, according to BIS estimates.

The BIS is primarily concerned with the accelerating pace at which the debt is being accumulated in China. Its “credit gap” benchmark measures the difference between current debt-to-GDP ratio and that ratio’s long-term historical trend. The BIS rates a reading above 10 per cent as cause for concern; China’s gap hit 30.1 per cent in March.

According to the BIS, this benchmark “has been found to be a useful early warning indicator of financial crises”.

Chart: China credit gap

Economists and investors have become increasingly concerned about the risks from excessive debt. In May, People’s Daily, the Communist party’s official mouthpiece, published an interview with an anonymous “authoritative person” warning that policymakers had not done enough to control debt growth and criticising overreliance on credit stimulus to fuel growth.

Overall, China’s debt is not high in absolute terms when compared to other large economies. Including government debt, BIS estimates China’s total credit outstanding at $27.2tn, or 255 per cent of GDP, by the end of March. That’s lower than the Euro area at 271 per cent, the United Kingdom at 266 per cent, and Japan at 394 per cent. The aggregate ratio for all advanced economies of 279 per cent. 

    Yet the speed at which China’s debt has accumulated — up from 147 per cent of GDP at the end of 2008 — raises special concerns, economists say. It is difficult for any country to invest such a large amount of capital efficiently within a brief period. The IMF estimated in June that $1.3tn in credit was outstanding to companies without enough cash flow to make interest payments. Excessive borrowing also explains why it now takes more than three units of new credit to generate one additional unit of GDP, up from less than 1.5 in 2008, according to the IMF. 

    The BIS, whose banking supervision committee formulates global rules on bank capital known as the Basel standards, said that policymakers should use the credit gap data as a tool for setting “countercyclical buffers” — additional capital requirements above the Basel standards’ minimum threshold. But it acknowledges that credit gap indicator should not be applied indiscriminately across countries. 

    China first breached the 10 per cent threshold in 2009 and has not yet experienced a crisis. Many analysts believe that China’s low level of foreign currency debt and its government-controlled banking system make crisis less likely. 

    “Authorities are expected . . . to apply judgment in the setting of the capital buffer in their jurisdiction after using the best information available to gauge the build-up of system-wide risk rather than rely mechanistically on the credit/GDP guide,” BIS said. 

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