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Government Claims China Debt Issue Under Control

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Many investors have their eye on China’s internal debt burden as they enter the second half of the year. The issue has been nagging for sometime and a recent repot by the McKinsey Global Institute, which stated that China’s total internal debt all but quadrupled between 2007 and 2014, and now stands at a whopping $28.2 trillion, or 282% of GDP, has raised concerns.

There’s little doubt that such an astronomical load for a country that serves as the engine of global growth is a serious issue and China’s “debt disease” is another reason many investors fear the Chinese economy is indeed headed for a hard landing sometime this year, said Andy Rothman, investment strategist at Matthews Asia. But while there may be a grain of truth in the hard landing scenario, in Rothman’s view, the bigger problem is that most investors have not examined or understood the debt issue in detail.

“If you simply know that the debt-to-GDP ratio has risen so much in recent years, it sounds very scary,” he said. “But it’s important to go into greater detail and see where the debt is concentrated and look at the ability of the borrowers to be able to service that debt in the Chinese context.”

Investors continue to be concerned about slowing growth in China and the Chinese government itself has said that meeting its 7% growth target—the lowest GDP figure in six years—this year is not going to be easy. But in Rothman’s view, China should be “given the benefit of the doubt because they have a good track record of 10-15 years of managing their problems in a fairly pragmatic way.” Here are some of the key points:

Private Debt Low

Most of the debt load lies with Chinese non-financial corporates and stands at around 125% of GDP, according to McKinsey. And yet Chinese companies are not overleveraged or overextended, Rothman said, and have been steadily deleveraging over the years. The International Monetary Fund (IMF) estimated that the median leverage for private Chinese companies fell to 55% in 2013 from 125% in 2006, which means that contrary to conventional wisdom, their debt problems are really not so serious, Rothman said.

Redirecting Funding to Encourage Business  

China’s state-owned enterprises (SOEs) have a huge amount of debt, largely because they are the greatest beneficiaries of funding from state-controlled banks. However, the numbers show that lending from the state-controlled banking system is increasingly going into private companies and away from SOEs, Rothman said, and this is important because private businesses have become the greatest driver of economic growth in China.

“The Chinese economy is becoming more market oriented even if it is still largely under government control, which means the banks are instruments of the state and capital allocation is not as optimal as it should be,” he said. “But things are changing and it’s important to note that all state-owned institutions are backed by the Chinese government, which is fully liquid.” Increased State-Owned Enterprise (SOE) Reform Likely

Rothman expects that the Chinese authorities will undertake a new round of SOE reform that will address the debt issue, closing out the most indebted and inefficient players. This, he said, will then allow private companies – small- and medium-sized enterprises – room for greater growth.

Local Government Debt Swap

Investors are optimistic about the Chinese government’s recent initiative to bail out heavily indebted local governments by allowing them to issue around $420 billion in municipal debt to refinance high interest rate, short-term bank loans that funded risky real estate and property undertakings.

The move is positive for China,, said Brian Jacobsen, chief portfolio strategist at Wells Fargo, and reminiscent of the founding of the U.S. in 1790, where the federal government took on state-level debt that had been incurred during the Revolutionary War

“With much of the debt being shifted to the national level, where it will be more transparent and better managed, there’s greater scope for growth and this is also an important step toward the internationalization of the Renminbi, which is key for China,” he said.

External Debt Low

China is lucky in that its external debt is low and has not risen past the 2008 level of 10% of GDP. This compares favorably to most other Asian countries, whose external debt profiles are not as positive.


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