China is one of the world's most indebted significant economies, with both governmental and private debt. Worse, its state-owned banks, notably in the real estate industry, are sitting on mounds of bad debts and non-performing loans. And that's only the tip of the iceberg.
China may be the world's creditor, but it is also heavily in debt. China is one of the world's most indebted significant economies, with both governmental and private debt. Worse, its state-owned banks, notably in the real estate industry, are sitting on mounds of bad debts and non-performing loans. And that's only the tip of the iceberg. There's a mountain of shady debt, off-balance-sheet financing, wealth management products, and local government funding vehicles beneath it all. Overall, China's debt is far higher than it looks at first appearance, and it is so high that some analysts believe it is at risk of exploding, causing significant harm to the global economy. What does this mean for global economic stability and Western concerns about China's ascent to prominence in international affairs?
China's spectacular economic development appears to be coming to an end. The poor world, particularly those nations that rely on exporting natural resources to China or on Chinese help, may bear the brunt of the consequences. People and corporations significantly invested in Chinese firms and equities will be the biggest casualties in industrialized nations such as the United States. There may be some good results in the long run. A Chinese economic collapse, or a severe economic slowdown, might hasten the migration of international enterprises from China, as well as a rebalancing of global supply networks. This would reduce the world's reliance on China and potentially boost economies in countries like Vietnam, India, and Indonesia, which are eager to welcome international industries that have relocated from China. However, the advantages will take time to manifest. Negative consequences will be felt right away.
If China's economy fails, it will have an impact on all of its major trading partners, which essentially includes the whole globe. Slower and more costly exports, as well as weaker demand for imports, will hurt countries all around the world. Due to epidemic measures like as fuel limitation, energy rationing, and port interruption, Chinese businesses are experiencing supply chain disruption, increased input costs, pollution controls, and logistical challenges. The price of goods at the factory gate, or factory-gate pricing, has been continuously growing. Factory inflation has reached its highest level in 13 years as a result of all of these factors.
The economy is slow, and construction is down. Factory outputs, which were once the engine of China's economy, have slowed. Steel imports are decreased. In October, coal imports were lower than in September. A slowdown in new building in China might hurt energy and coal exporters like Mongolia and Russia, as well as raw material and mineral exporters in Africa and other emerging countries. Companies with a lot of money invested in China will suffer as well. Furthermore, U.S. pension funds, individuals, and institutional investors would incur losses as a result of their investments in the $2.1 trillion in Chinese firms listed on American markets. Holders of China's foreign currency debt would be exposed to a $2.4 trillion loss. Developing countries, dependent on the completion of infrastructure projects through China’s Belt and Road Initiative, could be left with unfinished building sites, highways, and power-generation plants that prove to be both expensive and useless. Currently, Belt and Road projects are valued at over $1 trillion across 139 countries around the globe. In short, everyone, from the most to the least developed nations, could be impacted by a collapse of the Chinese economy.
Evergrande, China's second largest real estate developer, defaulted on a short-term loan in June 2021, resulting in the Chinese government freezing the company's bank accounts. For months, the issue dominated headlines, with fears that if the business defaulted on its $305 billion in liabilities, the consequences would not only harm the Chinese economy, but also the world economy.
Another Chinese developer, Fantasia Holdings Group, skipped a $206 million payment on five-year dollar notes in October. Cheergain Group, a subsidiary of China Properties Group, defaulted on $226 million in debt payments later that month. Modern Land China, another developer, almost missed its payment of principle and interest on a $250 million bond almost at the same time. Sinic Holdings, a homebuilder, is the newest member of the default club, having defaulted on a $250 million loan. Kaisa Group Holdings, another Chinese developer, is in danger of defaulting on its loan obligations. The firm was worth roughly $1 billion when the probable default was reported, but its stock price dropped 15%.
These examples have received a lot of attention, but they are a bit of a red herring because China's debt extends much beyond the real estate industry. China's foreign debt, including U.S. dollar debt, was estimated to be $2.4 trillion at the end of 2020. The country's overall governmental debt surpasses 300 percent of GDP, while corporate debt is $27 trillion. China's public debt is already 60 percent greater than the global average, and the debt-to-GDP ratio is increasing at an annual pace of roughly 11%. China's debt is exceeding its GDP growth, which has been less than 11% annually for the previous 11 years.
Because the majority of commercial banks in China are state-owned, they frequently make choices based on government decree rather than economic prudence. This involves lending money to state-owned, state-controlled, or state-favored businesses and sectors despite the danger of not being paid back. As a result, bad loans at Chinese banks are expected to reach $540.79 billion by 2020. Chinese banks also have $990.22 billion in non-performing loans in danger of default, which are known in China as "special mention debts." However, the true number of potentially troubled loans is much larger.
Last year, pandemic regulations allowed many firms to postpone principle and interest payments, but the loans stayed on the books as "regular." Many of these loans might fail once payments resume, but there is no evidence on the records that any of them are in trouble. Non-performing loans can be "hidden" by transferring them off of banks' balance sheets and onto the balance accounts of organizations formed particularly to absorb non-performing loans.
Because China's classification of non-performing loans differs from that of the United States, troubled or possibly distressed loans may be undercounted. Many of China's "regular" loans would be classified non-performing in the United States, where non-accrual loans, as well as loans that are 90 days past due but still accumulating interest, would be labeled non-performing. Because China has five types of issue loans, this is a considerably tougher definition of non-performing loans. Loans may be classified as "special mention" on Chinese banks' balance sheets rather as non-performing loans, despite the fact that the probability of failure is quite high. The loans are often backed by inflated real-estate assets, and banks regard the loans to be regular even if the firm that accepted the loan is in financial distress.
Non-performing loans are frequently packaged and sold to investors in order to remove them off a bank's balance sheet. As a result, the amount of non-performing loans on the balance sheet would be significantly larger if these sales had not occurred. The price of these bundles of non-performing loans is determined by the statistical chance that the debts will be repaid, which is important to investors. The package may be sold at a higher price since the repayment risk is hidden. Over 70% of non-performing loan packages, according to researchers, were resold at inflated rates. Furthermore, because of the way the bundles are formed, even if the loans are no longer on the bank's balance sheet, the bank may still be the ultimate guarantor. As a result, the true exposure of Chinese banks to non-performing loans might be significantly larger than disclosed.
Comparing the volume of loans provided by banks to the income produced from such loans is a proxy measure for the health of bank loans. Banks in China have observed a decline in loan revenue, implying that non-performing loans are larger than stated. This truth is sometimes concealed by Chinese banks reporting high profits, but profits are subjective, and bad loans that have been transferred off the balance sheet may not be included in the revenue minus expenses computation. However, the ratio of interest revenue to loan volume is a strictly objective statistic that reveals Chinese banks are not performing as well as they appear to be.
From Bad to Murky
The so-called shadow banking business, which involves lending through non-traditional financial organizations, is a parallel, overlapping source of debt. In 2020, the overall value of the shadow banking industry was anticipated to be around $13 trillion USD.
The wealth management product business, which is worth $1 trillion, has even more shady loans. Banks sell wealth management products as low-risk, high-yield investments, with a large portion of the earnings going to the property sector. The government establishes rigorous regulations on what grade of debt may be included in these packages, similar to what happened during the U.S. mortgage crisis, but banks have discovered methods to bundle inferior debt and sell it at higher rates.
Local government debt is another cause for concern. As part of China’s development plans over the past decades, the central government has pressured local governments to increase economic growth through infrastructure spending, funded through local government financing vehicles. China's local government debt was officially $3.97 trillion at the end of last year. Experts, once again, feel the true figure is significantly higher. There is also "hidden debt," which is the result of local governments acting as guarantors for other organizations that borrowed money. Off-balance-sheet borrowing takes place through so-called local government financing entities, which are created only for the purpose of borrowing money and investing it in local infrastructure development. As a result, the debt is recorded on the accounts of the local government finance vehicles rather than the local government, despite the fact that the local government is ultimately responsible for the loans. Over the last eight years, the debt value of these local government financing vehicles has nearly quadrupled. According to Goldman Sachs, "hidden debt" in China might be as high as $8.2 trillion, or over half of the country's GDP.
Local governments have issued a record amount of bonds. They had a quota of $3.75 trillion in 2021, but the central government reduced it to $3.65 trillion in an effort to decrease debt. Even if bond limits are reduced, debt is still piled on top of debt. 60% of the profits from these bonds were utilized to retire maturing debt rather than investing in infrastructure.
Selling land to property developers accounts for around a third of local government revenue. This puts local governments, developers, and banks in a situation where they are influenced to provide more loans rather than less. Making dubious real-estate loans while carrying bad debts over to the following quarter has allowed banks to increase their on-paper earnings. According to some estimates, the property industry accounts for around 29 percent of China's GDP and roughly 30 percent of all bank loans.
Chinese enterprises' overseas bond defaults are on the rise, reaching $8.7 billion in 2021, with real estate liabilities accounting for 34% of the total. Many Chinese developers, like Evergrande Group, whose $305 billion debt is equal to nearly 2% of China's GDP, Fantasia Properties, which is in danger of defaulting on $4 billion, and Tahoe, which owes around $6.7 billion, are having liquidity challenges, raising the chance of default. Bond defaults in the real estate industry soared by 159 percent year over year, and there may be more to come.
A Paper Tiger?
Despite a coronavirus economy, China was reported to be the world's greatest beneficiary of foreign direct investment in 2020, with $163 billion, albeit much of this investment went through Hong Kong, so this statistic may be deceptive. However, the fact remains that China is one of the world's most popular places for foreign direct investment. While there has been a general trend of foreign enterprises leaving China, there are still 175,400 international companies registered in the country, attempting to take advantage of the country's 1.4 billion potential clients. Doing business with or in China looks to be getting riskier in light of the large debt and bad loans handled by local banks. Infrastructure investment and new building projects will come to a standstill as the economy continues to decline and banks tighten their lending policies. This will drive up unemployment, decreasing demand for everything from building materials to factory inputs to consumer goods and services.
The Chinese economy is unlikely to continue to develop at the amazing rate it has over the previous three decades. Aside from Xi Jinping's and the Chinese Communist Party's damaging control policies, the Chinese economy is maturing at a time when the population is aging and the workforce is declining, resulting in lower future growth possibilities. Since 2008, much of the expansion has been powered by debt, a potential problem that has been overlooked because job creation and rising living standards are priorities. Job creation, on the other hand, may be less of a motivator now, leading the Chinese Communist Party to be more ready to rein in debt and rein in areas of the economy that were permitted to run amok in the sake of higher development.
The Chinese Communist Party's ability to tackle all of these issues or entirely turn the economy around is exceedingly improbable. The Chinese economy is just too large and complicated to address the deeply rooted problems that have grown endemic. To bring China's economy in line with that of Western countries, particularly the United States, the Chinese Communist Party would have to make deep, systemic changes that it is unwilling to consider, such as decentralizing control, granting rural land rights, and exposing the economy to risky market forces.
While China's current economic challenges are severe, they do not portend the country's demise as a global force. The country will very certainly remain the world's second largest economy and the United States' principal competitor. However, China's role will shift in that it will become less of a driver of global growth and will no longer be rushing to become the world's dominant power.