China’s level of debt sets it apart from EM peers, and the rate of its debt buildup is nearly unparalleled
It turns out that China hasn’t just had a credit-fuelled expansion, it’s had one of the biggest in modern times. As new debt becomes less effective at creating growth, we’re approaching the point where a crash becomes increasingly likely and research from Goldman Sachs shows that a larger buildup usually means a harder fall.
“China’s debt buildup since the global financial crisis ranks as one of the largest in recent history (in the 97th percentile of debt-to-GDP changes in a sample of 55 countries over the past 50 years),” write Goldman Sachs analysts Andrew Tilton, Ken Ho, and MK Tang. “Deteriorating external conditions and declining investment efficiency have contributed to the debt buildup.”
China’s debt-to-GDP makes it an outlier among emerging markets
In absolute terms, Chinese debt-to-GDP is comparable to developed economies like the US and Australia, but as an emerging economy with a much lower income per capita it’s a clear outlier.
Most of that is corporate debt, 61%, with real estate and heavy industry leading the way by a large margin. That’s what you would expect from an emerging market, but it creates legacy debt problems for a country that’s already heavily leveraged and trying to transition to a more consumer-driven economy.
The flow of new debt comes with its own problems. State-owned enterprises (SOEs) in China have been taking on more debt since the financial crisis, while non-SOEs have been deleveraging, but non-SOEs have a much higher return on assets than the SOEs. So not only has the amount of new debt since the financial crisis been extraordinary, it hasn’t been allocated very efficiently.
A deep recession isn’t inevitable
“The aftermath of large debt buildups over the past half-century suggests that credit booms do not always end in deep recessions or banking crises,” write Tilton, Ho, and Kang.
They find that growth usually slows after a debt buildup, and a rapid debt buildup usually means a sharper drop in growth, but it’s not a hard and fast rule. They point out that China has an important advantages over other emerging markets that it occasionally gets compared to – most of its debt is domestic and policy makers want to avoid defaults, so you won’t have a situation where foreign investors start calling in large quantities of debt.