China: Till Debt do us apart
This is a follow-up piece to my earlier note, Debt-plomacy that highlighted how China has used its currency printing presses liberally, to accumulate a global footprint of strategic investments. As per data compiled by the American Enterprise Institute, and The Heritage Group, between 2005-2019, China is estimated to have invested over US$ 2 trillion in 150 countries globally, gaining political and social influence in return. For perspective, it is worth noting these investments were more than the addition in the total Indian GDP during the same period (US$ 0.8 trillion in 2005 to US$ 2.72 trillion in the last fiscal).
This global thrust by the Chinese, is underpinned by its ability to print money without apparently pushing up the CPI. One wonders if this is a uniquely Asian phenomenon where lower interest rates on savings actually spur people to increase savings, rather than consume (Gross Domestic Savings in China are 45% of its GDP). There are of course contributing issues like an ageing demographic profile, that is coming off a "one-child regime", tending to be relatively risk averse. China's personal consumption expenditure, for example, at <40% of its GDP lags peers India (60%), USA (65%), and Japan (55%).
This rather profligate expansion of the monetary base is not without consequences. China has emerged as one of the most levered countries with total debt (corporate, household, government) touching 303% of GDP (vs. 250% in 2015). In absolute terms, at over US$ 40 trillion, China accounts for 15% of all global debt. What is more worrying than the level of debt, is perhaps the country's worsening credit intensity. As per data compiled by Saxo Bank, pre Global Financial crisis China on average needed one $ of credit to create one $ of GDP. Since 2008, it requires 2.5 $s of debt to create one $ of GDP. It some ways, China is on a debt treadmill, having to keep running to stay in the same place. Higher debt intensity, a glitchy belt road initiative, and now coupled with the measures it needs to take in light of the Covid-19 crisis suggests that the leverage will continue to balloon.
Already defaults are near record levels with more than 150 companies having reneged on their commitments in 2019, amounting to US$ 19 billion. Complicating the situation is the existence of hidden local government debt, that analysts estimate to be in the range of US$ 6.5 to US$ 7.2 trillion. These are not comforting signs for an economy that is more than a little dependent upon its ability to refinance its debt.
While "this time its different" seems to be the catchphrase of many-a-analyst, one finds that in reality history often repeats. Comparing China to Japan of the 1980s and 1990s may appear simplistic, but there are remarkable similarities between the economies that bear highlighting. Japanese GDP too rose at a brisk 14.6% Cagr from the mid 80s to mid 90s. Japan too had a respectable foreign investment programme (FDI of US$ 400-450 billion between 1980-1995), that was accompanied by news coverage that was similar in vein, if not in scale, as with the Chinese. Japanese growth was also accompanied with surprisingly benign consumer inflation (1980-1989: 2.5%, even lower thereafter). Liquidity spurred inflation however was reflected in asset prices, which is also the case in China one suspects. The anecdote of how the Imperial Palace in Tokyo was notionally worth more than the entire state of California during the Japanese boom, is now well known. Japan too followed the high leverage route with total debt rising from 300% of GDP in 1980 to peaking at over 400% in 1994.
What ultimately derailed the Japan story was that the Bank of Japan (BoJ) had to raise rates in an attempt to curb the asset bubble that had been created. This led to a equity, and real estate price crash that impacted banks which had lent money against these assets. Ultimately government had to infuse funds in the banks and other organisations to keep them going. So while private leverage moderated, government debt expanded, keeping the overall debt levels unchanged (and even rising). The economy hobbled along, with Japan's GDP being 8% lower in 2018, than it was at its 1995 boom peak.
Will China follow the same course? Or what, if anything, will prick its economic boom, is difficult to say at this time. What one can say with some confidence that leverage driven growth, is akin to borrowing from the future. The more an economy levers, the longer busts it has to endure, till the excesses in the system are worked out. What is certain is that China is vulnerable to shocks by being highly indebted across virtually all segments (household, government, and corporate). For instance, while the Covid-19 crisis may serve as a alarm for global supply chains that have been hit due to over dependency on one country. Even if the current crisis passes, these supply chains may be prompted to diversify significant portions of their operations to other geographies, stressing the debt-financed infrastructure that China has created betting on becoming the manufacturing hub of the world.
Given China's authoritarian regime, territorial ambitions, a well equipped military, and a large population, a sharp economic slowdown (as is likely in this author's view), will have internal as well as regional strategic implications. If anything, the Japanese, and the Chinese experience should serve as a lesson to other economies like India against making rapid growth an objective, vs. sustainable, quality growth.
This global thrust by the Chinese, is underpinned by its ability to print money without apparently pushing up the CPI. One wonders if this is a uniquely Asian phenomenon where lower interest rates on savings actually spur people to increase savings, rather than consume (Gross Domestic Savings in China are 45% of its GDP). There are of course contributing issues like an ageing demographic profile, that is coming off a "one-child regime", tending to be relatively risk averse. China's personal consumption expenditure, for example, at <40% of its GDP lags peers India (60%), USA (65%), and Japan (55%).
This rather profligate expansion of the monetary base is not without consequences. China has emerged as one of the most levered countries with total debt (corporate, household, government) touching 303% of GDP (vs. 250% in 2015). In absolute terms, at over US$ 40 trillion, China accounts for 15% of all global debt. What is more worrying than the level of debt, is perhaps the country's worsening credit intensity. As per data compiled by Saxo Bank, pre Global Financial crisis China on average needed one $ of credit to create one $ of GDP. Since 2008, it requires 2.5 $s of debt to create one $ of GDP. It some ways, China is on a debt treadmill, having to keep running to stay in the same place. Higher debt intensity, a glitchy belt road initiative, and now coupled with the measures it needs to take in light of the Covid-19 crisis suggests that the leverage will continue to balloon.
Already defaults are near record levels with more than 150 companies having reneged on their commitments in 2019, amounting to US$ 19 billion. Complicating the situation is the existence of hidden local government debt, that analysts estimate to be in the range of US$ 6.5 to US$ 7.2 trillion. These are not comforting signs for an economy that is more than a little dependent upon its ability to refinance its debt.
While "this time its different" seems to be the catchphrase of many-a-analyst, one finds that in reality history often repeats. Comparing China to Japan of the 1980s and 1990s may appear simplistic, but there are remarkable similarities between the economies that bear highlighting. Japanese GDP too rose at a brisk 14.6% Cagr from the mid 80s to mid 90s. Japan too had a respectable foreign investment programme (FDI of US$ 400-450 billion between 1980-1995), that was accompanied by news coverage that was similar in vein, if not in scale, as with the Chinese. Japanese growth was also accompanied with surprisingly benign consumer inflation (1980-1989: 2.5%, even lower thereafter). Liquidity spurred inflation however was reflected in asset prices, which is also the case in China one suspects. The anecdote of how the Imperial Palace in Tokyo was notionally worth more than the entire state of California during the Japanese boom, is now well known. Japan too followed the high leverage route with total debt rising from 300% of GDP in 1980 to peaking at over 400% in 1994.
What ultimately derailed the Japan story was that the Bank of Japan (BoJ) had to raise rates in an attempt to curb the asset bubble that had been created. This led to a equity, and real estate price crash that impacted banks which had lent money against these assets. Ultimately government had to infuse funds in the banks and other organisations to keep them going. So while private leverage moderated, government debt expanded, keeping the overall debt levels unchanged (and even rising). The economy hobbled along, with Japan's GDP being 8% lower in 2018, than it was at its 1995 boom peak.
Will China follow the same course? Or what, if anything, will prick its economic boom, is difficult to say at this time. What one can say with some confidence that leverage driven growth, is akin to borrowing from the future. The more an economy levers, the longer busts it has to endure, till the excesses in the system are worked out. What is certain is that China is vulnerable to shocks by being highly indebted across virtually all segments (household, government, and corporate). For instance, while the Covid-19 crisis may serve as a alarm for global supply chains that have been hit due to over dependency on one country. Even if the current crisis passes, these supply chains may be prompted to diversify significant portions of their operations to other geographies, stressing the debt-financed infrastructure that China has created betting on becoming the manufacturing hub of the world.
Given China's authoritarian regime, territorial ambitions, a well equipped military, and a large population, a sharp economic slowdown (as is likely in this author's view), will have internal as well as regional strategic implications. If anything, the Japanese, and the Chinese experience should serve as a lesson to other economies like India against making rapid growth an objective, vs. sustainable, quality growth.
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