China’s debt surges after the Covid-19 shock, making nominal growth crucial for its sustainability

• Excessive debt has long been a concern for Chinese authorities, which explains the deleveraging efforts since mid-2017. The Covid-19, though, has brought Chinese authorities to the reality that the shock is too big that it can no longer prioritize deleveraging. However, it seems also clear that the worrisome debt dynamics have constrained economic authorities in their response to the Covid-19 shock.
• In this note, we update our estimates of debt dynamics in China. We find that total debt, as a percentage of GDP, rose as much as 11 percentage points of GDP in the first quarter of 2020, to 258% of GDP from 247% at the end of 2019.
• Most of the increase came from the corporate sector (excluding LGFVs), which resulted in a jump in 7 percentage-point jump in corporate debt to GDP, to 129% in Q1 2020. Specially, bank’s corporate loans rose to 81.1% of GDP from 76.4% and corporate bond issuance reached 18.4% in Q1 from 16.4% at the end of 2019. Caution seems to have remained as regards shadow banking borrowing because it still witnessed negative year-on-year growth rate during the first quarter of 2020.
• Compared with the corporate debt expansion, the rises in the government and household debt were less significant. On the government side, there was a rise in the on-balance sheet government debt from 38.5% to 41.0% in Q1 2020. Off-balance sheet public debt is much harder to estimate as borrowing by LGFVs and other public sector actors are not easy to estimate. Based on bond issuance, and aware that bank borrowing is not available, there seems to be a very moderate increase in off-balance sheet financing by LGFVs (less than 1% of GDP in Q1 2020).
• The household debt only experienced a moderate increase, to 57% of GDP. The current growth pace in household debt was not exceptional compared with the earlier growing trajectory since 2015 from 39.4% to 55.8% by end-2019. This might be related to the negative impact of Covid-19 on housing purchases and, thus, mortgages, as well as the push to increase precautionary net savings given the increased uncertainty.
• Last but not the least, while the overall situation looks worrying, we must bear in mind that the sharp rise in debt ratios come at a time when China’s real GDP growth has turned negative. If we counterfactually adjust the GDP, the denominator for our debt ratio, to experience 8% nominal growth for the first quarter in 2020, the overall debt ratio would have only increased to 250% in Q1 2020. In other words, a faster growing environment will significantly change our assessment regarding the speed of China’s indebtedness in Q1. This means that nominal growth holds the key to China’s debt sustainability.
• All in all, China’s strengthened stimulus measures in fighting against the economic fallout of Covid-19 has increased debt, especially corporate debt. However, the collapse in growth in a key reason for the 11 percentage points of GDP added to China’s stock of debt. If nominal growth (through real growth or inflation or both) is back soon, debt sustainability will be much less of an issue.

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