China’s mountain of loans

China’s debt compared to its gross domestic product has soared above the level in the United States as of the end of December 2015, according to the Bank for International Settlements. Concerns about a financial crisis in China rose after the International Monetary Fund’s first deputy managing director, David Lipton, advised Beijing that it was imperative to address its debt problem if it wants to avoid “serious problems down the road.”

How serious is the problem of China having more debt than the United States? U.S. debt is estimated at 250 percent of its GDP, and China’s is at 254 percent. Strictly speaking, China does not have greater debt than the U.S., but a higher ratio as compared to GDP.

As of the end of 2015, total U.S. debt was $45 trillion and China’s was $27 trillion. Japan’s debt has reached $16 trillion. The U.S. has more debt than China and Japan combined. The United States accounts for 29 percent of total outstanding world debt, China accounts for 17 percent and Japan for slightly over 10 percent.

Japan’s debt exceeds its GDP by 388 percent. The average debt ratio of wealthy countries is 268 percent, and that of the euro zone is 266 percent. China’s level is lower. Yet China has been singled out as a potential hotbed for trouble because of the level of corporate debt, which has swollen to 171 percent of GDP.

Japan’s corporate debt ratio as compared to GDP is 101 percent, the eurozone’s is 103 percent, and the United States’ is 71 percent. China’s government debt is at a passable 44 percent level, and its household debt is at 40 percent.

Can a high level of corporate debt be that threatening? Because of lagging capital market development, Chinese companies mostly raise funds through loans rather than the equity markets. Bank loans account for 90 percent, while funds raised from the stock market make up a meager 10 percent.

In the state-controlled Chinese economy, lending does not work as it does in the banking sector of market economies. Chinese banks are mostly state-owned. About 65 percent of loans go to state enterprises.

The Chinese economy is primarily driven by state enterprises, where revenues account for 67 percent of China’s GDP. Their combined assets reach 176 percent of GDP. Chinese banks heartily lend out money to state enterprises because they won’t likely go bankrupt, and if they do, they can be bailed out by the government.

The fast rise in bad debt looks worrisome, but is less so in terms of value. China’s nonperforming loans have actually been declining after peaking at 1.3 trillion yuan ($197.3 billion) in 2007 before the global financial meltdown. Questionable loans surged in 2014 and 2015, but in value remained more or less at the levels of 2007.

China’s GDP, which was at 27 trillion yuan in 2007, ballooned to 67 trillion yuan in 2015. But its bad debt levels have more or less stayed the same. China has become richer and can therefore afford more bad debt. The country’s ratio of bad loans was 1.83 percent as of the end of March 2016, below the world average of 4.23 percent and the OECD average of 3.55 percent average. Chinese banks have also piled up loss reserves of 170 percent against questionable loans.

Of the 10 largest economies, China is the only one that has been managing annual growth of over 5 percent. From the debt ratio, the U.S. is hardly any safer. We must watch the growth in debt and nonperforming loans in China rather than becoming apprehensive as a result of all the hype about a China risk raised by Western media.

Chinese corporate debt has risen sharply amid government-led structural reforms to address overcapacity. State enterprises have been ordered to tap into bond markets to raise new funds using their creditability rather than turning to banks. Borrowing costs have become cheaper through bond issues due to decreases in interest rates. Bond issues by Chinese state enterprises reached an all-time high of 2.1 trillion yuan last year, pushing up the corporate debt ratio. But financial risks have come down because loans with high interest rates have been refinanced and debt has been raised at cheaper rates.

What attracts our attention more is China’s massive restructuring and industrial overhauling. China aims to build its state enterprises into internationally competitive behemoths through mergers. It envisions creating companies of top quality after cleaning up its money-losing and “zombie” corporations. Economies of scale become a winning factor in traditional manufacturing industries as production costs come down by 33 percent while output is doubled. China wants to reduce capacity by 10 percent to 15 percent through mergers in hopes of bringing down its production costs by 33 percent and dominate the global traditional manufacturing scene.

We must not underestimate China’s streamlining in the manufacturing field. Korean manufacturers should not fall into the temptation of complacency by the restructuring and scale-down of their Chinese rivals. They must prepare to face them when the become 30 percent more efficient and price-competitive. That will be real competition.

Translation by the Korea JoongAng Daily staff.

JoongAng Sunday, June 19, Page 19

*The author is director of the China Economy and Finance Research Institute.

Jeon Byeong-seo