China's Growing Debt Challenge: A Closer Look
China, the world's second-largest economy, has experienced rapid economic growth over the past few decades. However, this impressive growth has come at a cost, and one of the significant concerns on the global economic stage is China's growing debt crisis. This article explores the key aspects of China's current debt situation.
The Scale of China's Debt:
China's debt has been rising steadily, both in absolute terms and as a percentage of its GDP. China's total debt (combined debt of the government, corporations, and households) is estimated to be well over 280% of its GDP, an alarming figure that includes debt owed by the government, corporations, and households. This level of debt has raised concerns about the country's long-term economic stability. China's government debt is shown on the chart below in relation to other developed countries.
The Causes of China's Debt Buildup:
Several factors contribute to China's debt problem:
Infrastructure Investment: China embarked on an ambitious infrastructure spending spree, building roads, bridges, high-speed railways, and more. While this has driven economic growth, it has also led to substantial debt accumulation.
State-Owned Enterprises (SOEs): Many state-owned enterprises in China have borrowed heavily to fund expansion and meet government-mandated growth targets. These entities often take on debt without adequate consideration of profitability.
Local Government Financing Vehicles (LGFVs): Local governments in China have set up LGFVs to finance local infrastructure projects. These entities have taken on significant debt, often off the government's balance sheet.
Property Market: China's property sector has been a major driver of economic growth, but it has also resulted in substantial household debt as people take out mortgages to buy homes.
The Risks and Challenges:
China's rising debt poses several risks and challenges:
Financial Stability: A high debt-to-GDP ratio increases the risk of financial instability, especially if economic growth falters, and borrowers struggle to repay their debts.
Corporate Defaults: Some Chinese corporations, particularly in the real estate sector, have faced debt repayment challenges, which could have wider repercussions in the financial system.
State Control: The Chinese government maintains significant control over its financial system, which can help manage crises but also obscures the true extent of debt problems.
Global Implications: China's debt situation has global implications, as it impacts international markets and commodity prices.
Impact on US Investors: Systematic risk related to China's debt has the potential to have an impact on U.S. stocks. For example, Tesla announced price cuts in China this month, Freeport-McMoRan has been impacted by the decreases in copper and crude oil prices, and Albemarle also took a hit this month with lower lithium prices. This is an example of how macro risk can impact investors and the need to stay patient and control emotion during periods of volatility.
Do We Need to be Concerned About the U.S. Debt as Well?
The chart below shows U.S, debt in red and China in blue. Is this a concerning trajectory for both global leaders? This is something we plan to write about in its own Market Watch to in the future.
In the old days we used to say when the U.S. caught a cold (recession), the rest of the world sneezed. With China being by the far the second largest economy in the world, when they have a recession, the rest of the world sneezes.
China reopening trade was one of the most awaited events for 2023, after the economy was shut down for 3.5 years in an effort to contain covid.
So far there has been no stimulus to the rest of the world, as we are all waiting for China to continue its growth as in the past. The big question now is will there be any growth for 2023 and into 2024, as they have internal issues (who doesn’t).
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This edition of Market Watch was written by RMH Analyst, Ashlyn Tucker, under the guidance of Richard Mundinger, CFA.