China’s debt ballooning since Covid-19 erupted but not through shadow banking

• China’s total debt continued to grow rapidly in the second quarter for 2020. Our earlier debt monitor pointed to a very sharp increase in the first quarter of 2020, especially as regards public debt. Such development, reflecting the Chinese government’s fiscal response to the Covid-19 outbreak, continued to be very visible in the second quarter of the year. More specifically, China’s surging debt ratio carried forward across the board during the second quarter, moving up by another 8 percentage points to 268.4% as a proportion of GDP.
• The largest rise stems from the corporate sector with its debt increasing from 162.6% to 166.2%. In particular, corporate loans and bond issuance grew by another 2.1 and 1.4 percentage points respectively. However, leverage from shadow banking continued to come down, with a negative year-on-year growth rate and its share of GDP even slightly decreasing. This shows that, while Chinese policymakers fight to control shadowing activities continues, corporates have been supported with massive lending again.
• The government debt also saw rapid accumulation and the broadly defined government debt-to-GDP ratio standing above 70% for two consecutive quarters. Similarly to the corporate sector, the increase mainly occurred in the government’s on-balance sheet, especially through the local government’s bond issuance, but less so in its off-balance sheet. The increase in China’s official on-balance public debt is clearer if one compares now (more than 40%) with the rather stable ratio of 37% to 38% over the last five years. In turn, off-balance sheet public debt, from local government financing vehicles (LGFV), witnessed only a slight rise, as indicated by bond issuance data. In fact, the total outstanding value for China’s LGFV bond grew at a much slower pace year-on-year during the second quarter than before.
• Both of the above patterns in the corporate and government sectors seems to suggest that Chinese government has become more willing to tolerate a larger debt burden as long as it happens on its balance sheet. Harder control, or even monitoring, of the off-balance sheet risk might be the reason behind this clear move.
• In addition to the expansion in the corporate and the government debt, household leverage also continued to expand steadily. In particular, household mortgage debt rose by 0.9 percentage point in the second quarter, in line with the rebound in housing investment.
• Finally, the persistence of the rising debt-to-GDP ratio notwithstanding the recent economic recovery implies that the growth pick-up has not been strong enough to offset the debt expansion. Actually, even if we assume that the first two quarters of 2020 experienced the same growth rates as they did in the first two quarters of 2019, the overall debt-to-GDP ratio would have still risen by 5.9 percentage points.
• All in all, China’s ongoing efforts to stimulate the economy is leading to a much faster accumulation of debt in Q2 2020. However, most of the efforts are happening within the balance sheet, both for corporates and the government. The choice reveals one of China’s key policy dilemma, namely the short-term trade-off between stimulating economic and financial stability. Such dilemma may be perceived as less concerning if debt accumulation is better monitored through on-balance sheet positions.

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