China continues to leverage, pushed by local governments while corporate debt moderates
China’s GDP growth bounced back thanks to the successful containment of the pandemic. At the same time, leverage continued with the debt to GDP ratio increasing fast comparing to the beginning of the year. This is still true for Q3 even with accelerating GDP growth. The increase in the debt to GDP ratio was 3.7 percentage points in Q3, less than in Q2 but with a higher GDP as the denominator (Chart 1). If the GDP remained the same as Q2, the debt rise could have reached 276%. In other words, economic growth has been the primary source for the relief in debt pressure for China, as we have argued in our earlier report.
Behind the increasing debt pile, the public sector is the key contributor followed by the household sector. For the former, both central and local governments widened their outstanding debt, causing the debt over GDP to rise 2.3 percentage points during Q3. The result is consistent with China’s efforts to use fiscal policy to stimulate growth. For the household sector, the overall debt to GDP rose 1.7 percentage points during Q3 and the continued increase in mortgage debt is a major force.
What did look different during the third quarter is the caution showed by corporates, with 0.4 percentage points decrease in debt to GDP. Banks’ corporate loans and corporate bond issuance continued to increase but only by 1.5% and 2.2% QoQ respectively (Chart 2). The authorities remain cautious towards shadow banking (including trusted loans and entrusted loans), causing the overall corporate debt to remain nearly unchanged from Q2 to Q3. Because GDP growth has bounced back quickly, the final corporate debt ratio as a proportion of GDP consequently decreased.
At the same time, local government financing vehicles (LGFV), an off-balance sheet corporate platform for the local government to support local infrastructure projects, seemed to have accelerated. Specially, the outstanding bond balance reported by the LGFV has increased by more than 10% QoQ in Q3, whereas the outstanding bond balance from the rest corporates decelerated (Chart 2). Although bond is only part of the LGFV debt, it again highlights the local government’s determination to strengthen fiscal-like support to stimulate the real economy.
While corporate loans and bond issuance decelerates, corporates’ cost of funding has increased. From the July to September, the 3-month SHIBOR, an indicator of China’s interest environment, rose from 2.1% to 2.7%, and now surpassing 3%. This is not a usual move as the world’s major central banks are still in an easing mode to bolster the economy.
Moving forward, the rapid rise from the end of 2019 to over 270% is already a sharp increase, which will have to take a longer time to absorb. Debt sustainability issues will depend on long term nominal growth and interest rate prospects. Moreover, the government deficit stemming from slower fiscal revenue growth and the increased pension spending amid population aging are also likely to push up China’s public debt. Thus, we expect China’s debt-to-GDP to continue to pile up, which means that China will join one more league table, namely that of the high indebted countries.