Deleveraging is no longer Chinese policy makers’ priority but rather stabilizing growth

Deleveraging the economy, i.e., reducing the overall indebtedness, has come to be one of the Chinese government’s priorities over the past few years. After that, both shadow banking and corporate debt have started to come down moderately until the Covid outbreak in 2020. Still, public debt continued to increase as the fiscal deficit, especially when measured broadly, expanded (see our?fiscal report ).?

However, the trend has radically changed recently. The reason is clearly visible: economic activity is plummeting in China due to the sharp reduction in mobility stemmed from the Covid-related lockdowns. Against the backdrop, policy makers’ priorities have been shifting towards supporting economic growth even at the cost of an increase in the overall debt-to-GDP ratio.?

In fact, the data is already confirming such shift of priorities in the first quarter of 2022, as China’s total debt ratio sharply increased to 269% from 264% of GDP at the end of 2021 (Chart 1). Although credit expansion (measured by the growth in total social financing) continued to slightly slow to 10.2% YoY in April from 10.6% in March 2022 (Chart 2), the slower economic growth probably implies that the denominator of the debt to GDP ratio will grows less, pushing up the ratio this year.?

China’s debt expansion during the early months of 2022 was particularly pronounced in the corporate and government sectors. Corporate debt increased by 7.66 trillion yuan in the first four months of the year from 6.11 trillion yuan during the same period in 2021. Such an increase reflects the policy response to the cash-strapped Chinese corporates suffering from the lockdowns. As the objective of liquidity injection is to offer immediate rescue to the impacted corporates, the share of new short-term corporate loans has increased from 7.9% in 2021 to 26.6% during the first four months of 2022.?

The credit expansion also points to a further increase in government debt. Chinese government had actually already set an expansionary baseline for fiscal policy in 2022, even before the realization of the Omicron outbreak. In fact, the official fiscal budget deficit for 2022 (3.37 trillion yuan) was originally only slightly lower than that of 2021 (3.57 trillion yuan) but it has turned out to be much bigger after receiving 1 trillion-yuan remittance from the PBoC. However, the fiscal situation has turned out to be much more difficult than expected. Up to April, government’s tax revenue has plummeted by 7.6% YoY. Value-added taxes dropped on the back of the anemic retail sales and the government’s land sales are in negative territory due to a stagnant property market. If we also consider that fiscal expenditure is being shot up by covid-related needs, we should not be surprised to see a very rapid increase in the overall fiscal deficit and, thereby, public debt. As if this were not enough, the infrastructure program that the government has announced to support the recovery after the Omicron wave, if finally carried out, is bound to add a few more percentages of GDP in public debt in 2022.

Moving to the households, their debt over GDP barely moved from the end of 2021 (62.2%) to Q1 2022 (62.1%). Less borrowing behavior is related to households’ increased worries about the future and, with it, a rise in precautionary savings. The mirror of this trend is the weakening demand and the reduced incentives to invest in housing, which leads to a fall in mortgage loans. Against the backdrop, the 5-year loan prime rate was cut today from 4.6% to 4.45% as a way to support the demand for housing, and restrictions for housing purchases have also been lifted in a number of cities. That said, the effectiveness of both the rate cut and macro-prudential easing is yet to be seen because there are many structural issues eroding the households’ demand for properties, like population aging and slower income growth, which are hardly reversible with only countercyclical measures.

All in all, it seems clear that China’s priorities have changed again from controlling leverage to supporting growth. There is little choice left for the Chinese government but to unleash the credit power to ensure economic stability. Against the backdrop, the government is probably more concerned about a slower credit expansion than a faster one. That said, a further increase in leverage will not come without consequences. The liquidity injected to support cash-strapped corporates, as well as channeling funding into infrastructure projects, some of which may not be profitable, does not bode well for the return on assets and overall productivity in the future. This means that short-term growth gains are being traded for long-term potential growth rate.?