China Debt Rises to 226 Percent of Annual GDP

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BEIJING – Liu Shiyu, Deputy Governor of the People’s Bank of China, warned yesterday of the continuing perils of shadow banking and urged further efforts to control China’s rising debt. Commenting that China’s shadow banking sector was created using a “gambling mind set” directed only at short-term investments, he stated that the practice is pushing up costs for the real economy while making zero contributions to labor productivity.

As the Chinese economy slows down, the nation’s shadow banking industry—estimated by J.P. Morgan at US$7.5 trillion—is making it harder for the government to rein in credit and protect state-owned banks from default. The State Council also warned yesterday that China’s capital markets remain immature, containing organizational and systematic problems.

Recently, the Chinese Banking Regulatory Commission (CBRC) has stepped up supervision of the trust industry by tightening the approval process for financial companies seeking to enter new business fields and offer new financial products. It has also instructed smaller banks to limit their investments in assets that are not trading on exchanges using proprietary or interbank funds. Lastly, practices such as moving interbank lending off bank balance sheets are now banned.

Last year, China’s total gross debt, including government, corporate and household debt, was about 226 percent of its total annual GDP according to Credit Agricole, and this is expected to rise to 265 percent by 2016. This compares with a ratio of 105 percent in 2000 and 187 percent in 2012. These numbers have triggered concern over their similarities to the debt surges that pre-empted the Asian Financial Crisis in 1997.

The ratio of a country’s national debt to its gross domestic product (GDP) is an important measure of its creditworthiness, though not the only means to do so. By comparing what a country owes to what it produces, the debt-to-GDP ratio describes the given country’s ability to repay its debt. This can be written as a percentage—a ratio that expresses the number of years needed to pay back the debt if GDP was dedicated entirely to debt repayment.

Economists have yet to agree on an ideal debt-to-GDP ratio, but instead speak in terms of the sustainability of specific debt levels. A stable level is defined as one at which a country can continue to pay the interest on its debt without needing to refinance or otherwise impair its prospects for economic growth. Higher debt-to-GDP ratios create problems for a country’s ability to pay its external debts, and may result in higher interest rates from creditors. As this ratio rises and a country is increasingly unable to repay its debt, the risk of default looms larger and larger, which is likely to panic domestic and international markets.

Another way of looking at China’s economic position is through its recent overtaking of the United States in terms of economic size by purchasing power parity (PPP). While that may well be true, China has borrowed 2.5 times more money than the U.S. to achieve this position—and is also nearly double that of the Japanese debt ratio, now the world’s fourth largest economy.

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