Debt to GDP ratio of at least 275%, immense hidden debt by corrupted local governments, property developers default one by one… China’s debt bomb is ticking much louder. Can the communist regime postpone the day of debt reckoning?

Overview of China’s debt mountain

As reported by Bloomberg, China’s debt will probably break the record this year due to the central bank’s attempt to boost credit and struggle with the economic downturn. According to a Beijing-backed think tank, China’s total debt as a percentage of gross domestic product is projected to climb by 11.3 percentage points to about 275% this year. Although this figure is not internationally excessive compared to highly indebted countries like France or Japan, there is reason to worry because China’s huge hidden debts is unknown, as provincial and lower-tier officials have concealed obligations they have incurred; and are not included in the statistics. 

China’s debt has dramatically increased in the past decade, which is, according to Reuters, mostly due to credit poured into state-owned enterprises following the global financial crisis. From a broader perspective, the debt mountain has long been piled up since the giant economy started to binge on debt to fuel its growth.  

Photo: Bloomberg.

Some analysts said China’s indebtedness remains manageable as it incurred relatively little foreign debt, at $2.7 trillion last September. Yet, according to a commentary by famous columnist Gordon Chang in Newsweek, history shows the most severe and long-lasting financial crises happened to countries that owe money to themselves.

Chang explained, “In external-debt crises, foreign parties suffer when debt is compromised. The reduction of debt, of course, is politically popular in debtor countries. In China’s case, every solution involves domestic losers—the borrowers are largely domestic—so the crisis will not end until the Communist Party forces local parties to bear severe consequences.”

According to Minxin Pei, professor at Claremont McKenna College and a nonresident senior fellow of the German Marshall Fund of the United States, although China’s banking system is still standing, many warning signs have appeared, foretelling an imminent debt reckoning.

Sign #1: Bank runs and domino effect

The sudden freeze of cash withdrawals by four banks in Henan on April 18 sparked the cash crisis, which has raised serious concerns over the financial health of the country’s smaller banks.

According to Professor Minxin Pei, small rural banks in Henan were driven into insolvency due to weak supervision, poor risk management, and corruption, which are systemic among nearly 4,000 small and medium-sized banks in China. And there is a high possibility that other similar banks will fail soon.

Coincidentally, when Henan authorities were suppressing the victims of bank failure with abusive tactics instead of helping them. Authorities in Shanghai had secretly put on trial a former billionaire who allegedly manipulated a medium-sized bank in Inner Mongolia to fund various illegal schemes. The 2019 bailout of the failed bank cost several billion dollars.

Financial Times reported a rise in bank runs among China’s 3,902 regional lenders over the past few years. Many experts warned of a chain reaction threatening the financial sector’s stability, wherein their counterparties and lenders, particularly larger banks, could incur huge losses.

Several days ago, Bloomberg disclosed that China’s banks might face mortgage losses of about 350 billion dollars in a worst-case scenario as confidence in the country’s real estate market plunges.

Sign #2: Debt-ridden real estate sector

China’s debt-ridden real estate sector is the most dismal alarm bell of its debt reckoning. Following the default of China Evergrande Group, the most indebted real estate developer worldwide with more than 300 billion dollars in liabilities, a record number of defaults among Chinese developers have shaken the whole economy, whose growth significantly relies on the property market.

Bloomberg cited data from Teneo, saying that some 28 of the top 100 real estate developers have either defaulted or negotiated for debt extensions with creditors over the last year. The ongoing crisis aggravated as hundreds of thousands of homebuyers began a mortgage boycott due to unfinished projects in over 90 cities across China, raising concerns over broader systemic risks.

Last week, CNBC reported that China’s real estate sales would drop 30% this year, according to credit rating agency Standard and Poor’s Global Ratings (S&P). This figure was even worse than the financial global market crisis in 2008, when the fall was around 20%.

To worsen the confidence in the property market, recently, Evergrande has been back on the front pages after three of its top executives were asked by the director board to resign on corruption charges. An internal investigation confirmed that Chief Executive Officer (CEO) Xia Haijun, Chief Financial Officer (CFO) Pan Darong, and executive Ke Peng embezzled approximately 2 billion dollars from third-party loans. 

Sign #3: Debt-laden local governments

As land sales accounted for a significant part of local authorities’ revenue, the real estate crisis immediately drove local governments into grim prospects. According to Nikkei Asia, property market deadlock and falling tax receipts are estimated to cause a 900 billion dollar shortfall (equivalent to 6 trillion yuan) in local government revenues this year. It would be difficult for local government financing vehicles (LGFVs) that have significantly borrowed from banks or issued bonds to service their debt.

SCMP reported a rapid rise in the number of LGFVs since 2008, with Guangfa Securities estimating that up to 3,060 LGFVs sold debt in the public bond market. “These platforms, opaque in nature, are often used to raise funds for infrastructure spending that does not immediately generate returns, leading to the accumulation of hidden debt in the regional economy,” stated the news outlet.

China’s National Audit Office 2017 noted that some local government officials had “incorrect views” about their political accomplishments and abused excessive borrowing to boost their performance. According to the audit report, some cadres neglected financing guidelines, ignoring whether they had the means to repay the debt before launching a project. 

SCMP highlighted that the central and local governments have never published the scale of off-balance sheet borrowing or which lenders are exposed. According to Lu Ting, chief China economist at Nomura, local government hidden debt, including loans and bonds, might reach 7 trillion dollars or 44% of China’s GDP by the end of 2020.

For example, Guizhou, a populous southwestern province famous for making liquor Mao-tai, had its LGFVs defaulted on at least 68 debt products since 2018. In 2020, the province’s debt to revenue ratio was estimated at 706.56 percent. “The province’s Dushan county admitted “reckless borrowing” after it embarked on a construction spree between 2016-20, which included a number of white elephant projects,” said SCMP.

Acknowledging the situation, in recent years Chinese central authority has accelerated supervision of LGFVs, and has been promoting the market-oriented transformation of LGFVs since 2015. However, according to Guangfa Securities, such a transformation of LGFVs into commercially viable operations necessitates a favorable regional environment. Not all local governments possess profitable businesses suited for developing the platforms.

Sign #4: Large banks and non-performing loans

Large banks in China are also confronting a debt puzzle. They are trapped in the ambitious Belt and Road Initiative (BRI) with tens of billions of U.S. dollars in loans to developing countries, with a large fraction likely to become non-performing as the debtors fail to service the debt due to economic recession.

Nikkei Asia noted that the recent economic breakdown and the collapse of the Sri Lankan government will likely force Beijing to write off a large share of the loans. The troublesome situation abroad will hinder Chinese banks from helping bail out insolvent small or medium-sized domestic banks.

According to the Financial Times, besides the pandemic, the sharp deterioration of the BRI’s loan portfolio in the last two years was also attributed to the flaws in the program’s design, including an overall lack of transparency, poor risk management on projects, and the participation of many of the world’s riskiest debtor nations.

Why was the Chinese Communist Party ready to lend money to these impoverished countries governed by corrupt authorities? Why are environmental and social impact studies almost always absent from BRI infrastructure projects? According to various international analyses, the real incentives for the Chinese regime behind BRI investments are gaining military advantage, grabbing host countries’ natural resources, and expanding geopolitical influence.

Sign #5: Economic slowdown

Given the four above-mentioned warning lights, a systemic collapse is more likely to happen today than before as China can no longer maintain a high growth rate. 

Debt and economic slowdown create a vicious circle: Severe economic downturn, partly due to Beijing’s zero-tolerance Covid policy, has made the debt burden difficult to be managed or even concealed. Vice versa, rising debt and falling income induce households to cut spending, likely worsening the economic downturn. 

In late July, SCMP cited the IMF’s “World Economic Outlook,” saying that China’s economy will grow by merely 3.3%, down from the 4.4% forecast in April. 

Conclusion and Prospect

To conclude, China’s debt bomb is ticking much louder, and the communist regime will probably face a debt reckoning soon. Bank runs, real estate defaults, debt-ridden local governments, non-performing loans overseas, and economic recession are ominous hints of a real crisis, which might be just the tip of the iceberg.

According to Chinese traditional culture, “debt” could be considered a kind of “karma.” Debt must be repaid one day, just as the law of karma retribution. Ancient sages believed that for karma to be alleviated faster, the debtor should cultivate their virtue and do good deeds. In other words, they should sincerely acknowledge their past misdeeds, be truthful and gracious to their creditor, and sustain a patient attitude while paying back debts. However, the communist regime in China appears to lack these things.

The Chinese communist authority has answered back with abusive tactics to conceal its wrongdoings. They include violent attacks and harassment to silence protesting depositors in Henan recently, how they brutally suppressed students calling for democracy in Tiananmen Square or persecuted Falun Gong practitioners petitioning for their freedom of belief. The CCP has accumulated not only huge monetary debt but also non-refundable moral debt. 

Although it is hardly possible for a particular individual to change the whole system, each person must choose a righteous attitude while facing hardship. When the day of debt reckoning comes, the good people could still be saved.

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