Contacts
Opinions

China Is in the Red

, by Fabrizio Pezzani - ordianrio di programmazione e controllo nelle pubbliche amministrazioni, translated by Alex Foti
The sum of public and private debt has reached more than 200% of GDP, while liquidity has grown by a factor of five in the last seven years. An export based economy with low wages and low domestic consumption has created vast internal debt during the crisis

The time has come to worry about China's internal debt, a problem so far eclipsed by two decades of rapid growth.

As in all planned economies, China's currency (renminbi or yuan), pegged to the Hong Kong dollar, is not convertible abroad, and for international transactions it can only be exchanged into US dollars at government agencies. The exchange rate is kept artificially low to boost exports. Consequently, real domestic circulating monetary base becomes hard to control in absolute values, but the underlying trends and growing levels of risk are for all to see.

Corporate debt and local government debt are the most critical elements in this growing monetary base. The country's tumultuous pace of growth, which has been pivotal in dragging the rural part of the country out of poverty, has been based on an industrialization strategy driven by low labor costs and increasing economies of scale. Low wages favor exports but restrain domestic consumption, so that the whole of the Chinese economy is export-led and this could be its death trap.

Chinese firms have grown in size by accumulating debt with government banks. When the financial crisis led to the economic crisis, these firms saw their sales volumes shrink. For the same level of fixed costs, net margins on revenues (already half of the average in the rest of the world) have dropped, so that indebtedness levels can no longer be sustained and bank loans can no longer be reimbursed. Banks are thus headed for a major default: many of them are worth less on the stock market than their book value. China's corporate debt, which had already reached a staggering 108% of GDP in 2011, is now hovering at 125%, equal to about €8 billion (Bloomberg BusinessWeek, November 2012).

Also local government is mired in debt. Local public administration accounts for 40% of tax receipts, but these are insufficient to cover their expenses, since local government agencies have entered a costly competition to build public infrastructure to meet rising social expectations. Credit is provided by government banks and a shadow banking system accepting as collateral inflated real estate assets. Today, as loans cannot be paid back, leveraging can no longer increase, and social expectations are being thwarted, the real estate bubble is fast deflating. As a consequence public debt has climbed from 59.4% to almost 66% of GDP in just a year (Bloomberg BusinessWeek, November 2012).

As the domestic monetary base has quintupled over the last seven years, fanning inflation and bringing banks close to a default, real domestic debt has possibly attained 200% of GDP. What are the structural imbalances and social repercussions brought by ballooning internal debt? Will China still be able to buy a lot of US Treasuries? Will its domestic problems create a domino effect for the global economy? The time has come to assess all the options.

Opinions