China’s debt problem

China’s debt has risen dramatically in the past decade, largely the result of credit fed to state-owned enterprises in the wake of the global financial crisis. To some, the debt mountain represents a threat to China’s stability and even the world’s economic health, while others argue such fears are overdone as most of the country’s debt is state owned and therefore, they say, manageable.

How did China go from being the juggernaut of global economic growth to a country seen by many as a ticking time bomb of debt that could send shock waves around the world if its credit mountain started to crumble?

The health of Chinese companies

China is taking on more debt, but the real concern is the rate at which its companies are borrowing. Since 2008, non-financial sector debt-to-GDP has risen at breakneck speed. Encouraged by government calls to support economic growth, companies gorged on cheap credit. Analysts estimate that two-thirds of corporate debt is in the hands of China's sprawling state-owned enterprises, many of which are unprofitable and inefficient.

Chinese listed companies

As borrowing increases and earnings flatline, many more Chinese companies are struggling to keep up with their repayments. A snapshot of Chinese corporate debt compared to earnings, as represented by a group of 1189 mid- to large-cap companies who reported net debt in 2008 and 2016, paints a bleak picture. The chart below analyses net debt/EBITDA, a ratio used to show how many years it would take for a company to pay back its debt if current metrics remained constant. The number of companies with a ratio between 0 and 5, a measure usually considered healthy, has fallen by 31.7%. The number of companies making a loss or companies with an unhealthy ratio above 5 has risen.

Number of companies

Listed in Hong Kong

Chinese companies listed in Hong Kong are generally considered to be among China's healthiest due to greater financial disclosure rules. The chart below looks at a group of 93 companies with listings dating back to 2011.

By December 2016, the number of companies with earnings at least three times the interest cover on their debt, a measure generally considered to be healthy, shrank from 66 to 49.

Number of companies

The impact on banks

Bad debts on bank books have been rising steadily as borrowers struggle to repay their loans. Officially, non-performing loans at China’s commercial banks total around 1.5 trillion yuan. But some analysts say the bad debt is as much as 14 times higher because lenders use various methods to conceal the true figure.
The chart below shows how the official figure has surpassed 2008 levels, when a major government clean-up of bad debt at state controlled banks caused the industrywide bad-loan level to drop by more than half.

Non-perfoming loans

Doubts of a hard landing

The major argument suggesting China likely faces a crisis is that other countries that experienced a similarly rapid increase in debt suffered a financial crash or economic downturn. But other experts argue the risk of a hard landing is low. China has little overseas debt, and a high national savings rate. In addition, most of the debt is state owned – state-controlled banks loaned funds to state-controlled firms – giving the government the ability to manage the situation.

Sources: Thomson Reuters Datastream; National Bureau of Statistics of China; Bank for International Settlements; Reuters
By Simon Scarr, Ashlyn Still and Jin Wu. Additional reporting by Neil Fullick | REUTERS GRAPHICS