A primer on China’s debt: Piling up slowly in 2018 but expect an acceleration in 2019

• If you think China’s monetary policy had become laxer in 2018, wait for 2019. The recent measures announced by the People's Bank of China (PBoC) on credit targets and new liquidity facilities, such as the introduction of central bank bills swap (CBS), to facilitate banks’ perpetual bond issuance mean growth is once again the core objective instead of deleveraging. On that basis, it is important to assess the leverage of the real economy in China to draw conclusions for 2019. In this note, we offer our own estimates of China’s total debt as well as the breakdown for the government, corporate and household sectors. Our debt estimates have two key advantages.
• 1. Timeliness: Our measure is two quarters ahead of the statistics provided by the Bank of International Settlement (BIS), but the aggregate numbers are very much in line with those of the BIS once published.
• 2. Accuracy of breakdown: Our estimate of public debt covers the whole local government debt, as it treats the local government financing vehicles (LGFVs) as public rather than corporate debt as in the BIS statistics.
• Based on our estimates, China’s total debt continued to grow gradually from 246% in 2017 to 248% of GDP in 2018 but in a milder way than in the past. In fact, China piled up debt by 8 percentage points of GDP a year in 2016, but the increase has been reduced to around 1 to 2% in the past two years. In other words, China has not stopped leverage but it seems to have tamed it for the time being. The key contributor to the deceleration in leverage is corporates, while public and household debt continues to rise unabatedly.
• China’s corporate debt came down rapidly from 134% in 2017 to 128% of GDP in 2018. Most of the reduction is due to private corporation’s efforts to divest assets, given the constraints in accessing credit, especially since the clampdown on shadow banking.
• Household debt grew from 49% in 2017 to 52% of GDP in 2018. Mortgages and credit cards are behind the surge, but we believe the risk is under control due to the still rapid increase in household income and asset valuation gains (especially on housing).
• Public debt surged from 63% in 2017 to 68% in 2018, mostly due to on-balance sheet local government debt. Consistent with our fiscal analysis, both central government debt and off-balance sheet local government debt (LGFV) have increased only slightly.
• All in all, 2018 was a year of deleveraging by Chinese authorities, at least for the first half of the year. The policies in 2019 so far bode well for growth, but clearly imply acceleration in debt of the real economy, especially in the private sector, i.e. corporate leverage starts to grow again. However, we do not expect the debt problem to pose any crisis-level threats. Because China’s nominal growth is high enough, the cost of funding is lower, and external debt is just too small. This does not mean that leverage is painless either. As Irving Fischer reminded us, expect lower potential growth rate and deflationary pressure over longer term.

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