Policy Bias in China: Fighting with Credit Leverage or Adding more Stimulus?

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A key gauge of the debt burden in Chinese economy exceeded 300% of GDP, the Institute of International Finance reported. Beijing was forced to maintain the trajectory of undesirable debt growth, increasing monetary and fiscal support in response to shocks in foreign trade, weakening foreign demand and activity in production and services sectors. Big tax cuts and following decline in state revenues has led to the need to ease restrictions on the issue of special purpose bonds by municipal governments in order to keep a stable pace of investment in infrastructure projects. This fueled growth of the national debt to 50.5% of GDP in 1Q 2018:

Chinese government increased quotas on the issuance of special purpose bonds by 59% compared with 2018. But in May local governments filled the quota by only 40%, issuing debt at quite an even pace. Recall that such bonds are paid off with the project revenues, and not from the taxes collected. Raising funds for unprofitable projects and higher risk credit on such bonds imply that local governments are risking facing with increase in borrowing costs in case they make an investment mistake.

The liabilities of the three main types of economic agents – the state, firms and households amounted to 303% of GDP in the first quarter of 2019, compared with 297% in the same period last year. The IIF report also showed that the debt burden grew at an accelerated pace in many countries after the trade tensions escalated.

While the authorities’ efforts to combat financing through informal channels (i.e., shadow banking) led to decline in much-inflated corporate debt in the non-financial sector from 158.3% to 155.6%, borrowing in other sectors has increased. Changes in the size liabilities can uncover more underlying processes if divided in four broad components: government debt, household debt, the financial sector, and the non-financial sector. By comparing changes of debt in each sector with the same period last year and the values ​​for given period with safe standards globally, we can try to make a qualitative conclusion about the policy bias: towards fighting leverage or increasing stimulus.

Below is a diagram showing the debt-to-GDP ratio by sector for the first quarter of 2019, as well as a change from the same period last year:

The most rapidly growing debt was household debt (from 49.7% to 54%), and debt in the non-financial sector, which is the “main customer” of shadow money markets, slightly decreased from 158.3% to 155.6%. Three of four sectors (except non-financial one) are having quite safe levels of debt when comparing it with world average. Despite conflicting rumors about the course of fiscal and monetary intervention, Chinese authorities, as can be seen, managed to combine prudently stimulus measures with restrictions on shadow financing (reducing debt burden in the riskiest sector and increase it in those where it is reasonable).

At the same time, the value of China’s total debt in absolute terms exceeded $40 trillion dollars, which is almost 15% of the global debt.