MNI INTERVIEW2: China Should Cap Leverage Growth-Advisor

China should cap the rate of increase in its total debt ratio to 4-10 percentage points of GDP a year over the next five years, as the country pursues more sustainable growth and tackles a local government off-balance sheet debt pile which could total more than a third of total output, a prominent policy advisor told MNI in an interview.

China's total leverage ratio should jump by close to 30 percentage points this year to no more than 275% of gross domestic product, after the authorities responded to the Covid-19 pandemic, Zhang Xiaojing, head of the Institute of Finance and Banking under the Chinese Academy of Social Sciences, told MNI. This would be the second-biggest annual jump on record, after 2009, and, while the ratio is set to continue to rise, the key will be keeping a lid on the rate of increase as the economy expands by over 5% a year through till 2025, he said.

"The rise has been too fast for the year, which is understandable considering the unprecedented blow from Covid-19 … We need to pursue leverage stability as a key task for preventing future risk," he said.

LEVERAGE CAP

China should limit net growth of debt to nominal GDP to within a range of 4% to 10% a year during 2020-2025, Zhang said. While this will not be easy, he noted, that the 2017-2019 deleveraging campaign kept growth in debt to 6.6 percentage points a year, down from an annual 10 points from 2015-2016.

A key task will be tackling debt smuggled off balance sheet by local governments.

While it is difficult to measure these liabilities precisely, Zhang's team, after years of work, calculated them at about CNY32.8 trillion, or 36% of GDP as of the end of 2018, with a possible range from CNY16.8 trillion to CNY53.5 trillion.

Banks are very exposed to these liabilities, Zhang noted, with some CNY26 trillion of local government debt in the form of bank loans, and banks also holding 95% of bonds issued by local governments and their funding vehicles.

Beijing is still considering how best to deal with local government-backed debt, but the process will be long and gradual, Zhang said. Central government could take some liabilities onto its own books, given its own relatively modest debt ratios and in recognition of the role played by local government borrowing in boosting the economy, he added.

From 2015-2018, the government swapped CNY12.8 trillion of local government debt, mainly short-term bank loans, into low-cost bonds, according to Wind.

It could do something similar again, setting up special fund-raising institutions or issuing more central government bonds, Zhang said, suggesting that China could learn from Japan's experience in the area.

DEVOLVING TAX

Central government could also devolve more tax resources to local administrations. In addition, some struggling local governments and state-owned companies might have to sell assets, Zhang said.

In the first nine months of this year, central government debt rose by 1.3 percentage points to 19.1% of GDP. Local governments' official and on-balance sheet liabilities increased 1.1 percentage points to 25.6%.

Much of the borrowing by local government financing vehicles is classified as non-financial corporate debt, helping push the indebtedness of Chinese companies to 159% of GDP as of the end of 2016, up from 95.3% in 2008 and well above the OECD's risk threshold of 90%. Some 40.9% of this non-financial corporate debt was associated with implicit guarantees from local government, and borrowing by state-owned enterprises accounted for 67% of the total.

Zhang pointed to the increasing proportion of funds from new borrowing which goes to paying interest on old debts.

Growth in interest payments has outpaced output since 2012, and is now again approaching the 2014 peak of twice GDP growth after falling to 1.5 times in 2019 amid the deleveraging drive, Zhang's study showed.

Household debt, in contrast, is still manageable, despite jumping 5.6 percentage points to 61.4% of GDP in the Jan-Sep period. Savings and personal wealth are also rising, Zhang noted.