China’s debt is out of control according to a new report today from CLSA Asia. The report is blunt and to the point regarding China’s problems with its debt load. Below is a summary from CLSA:
China Credit Growth
China is addicted to debt to fuel growth and this is obvious with the outrageous 58% credit growth in 1Q13. More than half of its debt was added in the past four years, which is equal to 110% of GDP or 2.9x GDP growth, and most of which came from shadow banking and bonds. Rising debt suggests the present growth rate is unsustainable. Current debt levels are manageable, but the risk is rising as debt is likely to continue to expand as fixed investment has a diminishing impact on GDP. Curtailing debt or investment increases the threat of a sharp slowdown, but that is more likely in 2014-15.
Total debt accelerated from 148% to 205% of GDP over 2008-12, boosting average GDP growth to 9.2% during that period. Debt has been used to support growth, which is similar to the USA doing QE except China has debt capacity. Local government debt has enjoyed the fastest growth, but we believe it is manageable at 135% debt/revenue, although it is a 0.4% drag on GDP. To protect the banks, the risk has shifted to wealth-management products (an estimated Rmb13tn market). The largest risk is in the trust companies, which essentially offer unregulated lending, but a clampdown is looming.
Investment-driven growth is not working, as efficiency is declining due to a rising capital/output ratio since 2008; a widening gap between bottom-up fixed-asset investment (FAI) and the gross capital formation (GCF) component of GDP; and the 50% surge in China’s cement stock over the past four years. Corporations and state-owned enterprises (SOEs) together contribute the largest component of debt at 115% of GDP. We analysed industrial, A-share and MSCI China companies and found that debt levels are sustainable given years of healthy profit growth. The risk is with the SOEs, which are financially troubled with ROEs at 5% and high liability to equity of 115%.
Xi Jinping has stated that ‘China’s development model is not sustainable’, as it has led to high debt and huge excess capacity with only 60% utilisation. We believe debt will continue to rise to 245% of GDP if Beijing targets 7% growth by 2015. There are no easy answers as China needs to slow growth and close down excess capacity.
How much debt is there?
China is becoming more and more dependent on debt for growth and this has become evident with the 58% YoY surge in total social financing in 1Q13. Total social financing (TSF), a measure of credit, has been steadily rising as a portion of GDP since 2008, from 22% to 30% even as growth slowed. The worry is that the fastest growth in social financing has been in less regulated shadow banking and the impact on GDP growth has been declining as total debt has risen to record levels.
The Chinese government has been working hard to increase transparency of debt levels and created TSF in 2011 to capture all net new debt and equity financing in China, including shadow banking. According to the People’s Bank of China (PBOC), TSF is a money-added concept showing how much total funding is provided to the real economy by domestic suppliers, mainly financial institutions but also households and non-financial entities via wealth management products (WMPs). It excludes central-government bonds, foreign direct investment, overseas debt and interbank transactions. By accumulating annual total social financing and excluding equity components, we can get a clearer estimate of the growth trend of China’s debt. We also need to add the country’s sovereign debt, external borrowing and informal lending to the estimate.
By taking outstanding bank loans, central-government debt and culminating social financing since 2002, we estimate total China debt (consumer, government and corporate) at Rmb107tn, or 205% of GDP, at the end of 2012. This excludes unfunded pension liabilities and is in line with Fitch’s estimate at 198% of GDP when it downgraded China’s sovereign-bond rating from AA- to A+ in April. China’s sovereign debt has been relatively stable, but the worry is that the central government will eventually have to bail out local government and off-balance-sheet debt from shadow banking.
We also did a bottom-up estimate of total China debt and cross-check it by looking at both funding sources of credit and users of credit, which yielded a similar total China debt/GDP of 205%. From credit providers, we estimate that shadow credit including informal lending is about 49% of GDP adding credit outside of banking system plus trust loans. There are several caveats in estimating total China debt:
1) Local-government debt where local governments are facing financing pressures.
2) The rise of shadow banking.
3) Unfunded pension and medical liability for which there are no reliable industry estimates.