China’s debt ratio hits record high as efforts to offset US trade war mean ‘there is no such thing as a free lunch’

Orange Wang
China’s debt ratio hits record high as efforts to offset US trade war mean ‘there is no such thing as a free lunch’

China’s efforts to offset the affects of the trade war with the United States have resulted in its overall debt level reaching a record high in the first quarter of 2019, with authors of a new study remarking “there is no such thing as a free lunch”.

Beijing policymakers scaled back their deleveraging campaign in a bid to help the world’s second largest economy, resulting in a growth rate of 6.4 per cent in the first quarter, the same rate as the fourth quarter last year, confounding analysts’ estimations of a further slowdown.

But the leverage ratio of China’s real economy, which measures outstanding debt of residents, non-financial enterprises and the government sector against the country’s nominal gross domestic product (GDP), rose 5.1 percentage points from the end of 2018 to 248.83 per cent at the end of March. This was the highest since the data series began in 1993, according to a joint report by the National Institution for Finance and Development and the Institute of Economics under the Chinese Academy of Social Sciences.

“There is no such thing as a free lunch,” the report from the two government-affiliated think tanks said. “The robust and better-than-expected economic growth in the first quarter was at the price of a sharp rise of the macro debt level.”

There is no such thing as a free lunch. The robust and better-than-expected economic growth in the first quarter was at the price of a sharp rise of the macro debt level.

Think tank report

Last year, China’s overall debt level dropped for the first time since records began as the government programme to rein in debt and risky lending began to have the intended effect.

But to battle the economic slowdown amid the trade war with the US, banks issued a record US$865 million of new loans during the first three months of 2019, according to the People’s Bank of China.

In addition, China’s central bank has cut the required reserve ratio – the amount of money banks are required to hold in reserve – six times since the beginning of last year, pumping more than 3 trillion yuan (US434 billion) of net liquidity into the banking system to boost lending, particularly to the smaller, private companies that have been hit hardest by the trade war.

The most recent cut was announced at the start of May, which unlocked around 280 billion yuan (US$41 billion) in reserves for small and medium-sized banks, with Beijing hoping to rely on tax and fee cuts of nearly 2 trillion yuan this year to stimulate consumer spending and reduce the burden on companies. But a wave of weak economic data in April showed again the fragility of the Chinese economy, sparking expectations for more fiscal and monetary stimulus this year, which could further increase debt levels.

The report, which was released on Wednesday, argued that China’s monetary policy had returned to an “easing” stance from a neutral one due to uncertainties created by the escalation of the trade war earlier this month on top of a weakening economic environment.

“The pendulum of stimulus policies to some degree caused the fluctuation with the leverage ratio and disrupted the market’s expectations and judgment on the structural deleveraging efforts,” the report said. “That went against the goals of curbing the debt level and preventing financial risks.”

The debt ratio of non-financial companies rose to 156.9 per cent from 153.6 per cent, according to the report.

“As much as 60 per cent [of corporate debt] is debts of state-owned enterprises (SOEs), and of that, more than a half are debts of [local government] financing vehicles,” the report said. “That is to say, a lot of [cooperate debt] is directly related to SOEs and local governments.”

If we want to curb the momentum of rising debt, the most crucial issue is how to handle the relationship between the government and the market.

Think tank report

The level of local government debt climbed to 21.4 per cent of nominal GDP from 20.4 per cent due to increased borrowing to fund infrastructure projects, while the annual growth rate of residential medium-and-long-term debt, a majority of which relates to mortgages, accelerated to 18.2 per cent from 17.3 per cent at the end of 2018 after the government loosened restrictions on the property market.

“If we want to curb the momentum of rising debt, the most crucial issue is how to handle the relationship between the government and the market,” the report concluded.

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