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The Chinese government’s answer to the 2008-2009 global economic crisis was similar to that of many other countries: Fix it with a big pile of cash.
While the U.S. and EU went down the path of quantitative easing, China unleashed a US$580 billion stimulus programme. The centerpiece of it was building roads, highways, bridges and other public infrastructure.
That was equivalent to 11 percent of the country’s GDP in 2008. At the time, China’s debt burden wasn’t much of a concern.
But that programme set off a corporate borrowing binge, as growth-focused provincial governments encouraged banks to lend to the private sector. China has since gorged on mountains of debt to get to where it is today.
Over the past 10 years, the total amount of debt accumulated by China’s non-financial corporations has ballooned from under 100 percent, to 164 percent of GDP.
The size of China’s economy has nearly tripled over the last decade. And the absolute level of non-financial corporate debt has grown 370 percent to US$21.5 trillion.
According to the Bank of International Settlements (BIS), a financial institution owned by the world’s major central banks, China’s total non-financial sector debt hit 255 percent of GDP in 2017. This includes non-financial corporate debt (as shown in the graph above), plus household debt, as well as government debt.
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That’s up from 211 percent in 2013. It’s close to the levels of Canada (290 percent), Finland (245 percent) and the U.S. (250 percent).
Beijing knows that too much debt is bad
Debt, even a lot of it, isn’t so bad if the return you get from it is higher than the rate of interest you’re paying. That’s difficult to measure, of course, for this kind of debt. But it’s clear that the ability of debt to generate economic growth in China, which is the point, is declining.
As shown below, despite ever-greater sums of money – debt – put into the economy, growth is slowing.
Knowing that it had a problem, in 2017 Beijing started cutting debt.
But it hasn’t been easy. For one thing, debt is like an addiction. It’s not easy to kick. Secondly, many informal lending channels get around the government’s efforts to clamp down on lending.
For example, we’ve written in the past about how property buyers and speculators have gotten around increased down-payment requirements by borrowing from informal lenders, who often charge higher rates of interest.
And sometimes buyers who qualify for loans scheme with developers to inflate the cost of the purchase. That allows them to take out a bigger loan, and gives borrowers more cash to finance other purchases.
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The government imposed harsh punishments for operators of informal lending schemes. But not only real estate speculators were hurt. Hundreds of thousands of small and medium enterprises (SMEs) rely on informal lending for capital. They’ve had a big source of capital cut off.
On a related front, the government also cracked down on sales of so-called "wealth management products". That was one of the key ways Chinese commercial banks had channeled money into real estate and inefficient heavy industries (like steel, coal and aluminum). Growth in these slowed to 1.7 percent in 2017, from 23.6 percent in 2016.
Beijing also hit the once-booming peer-to-peer lending industry (online platforms that match small borrowers with lenders, who charge higher than market rates).
So while Beijing managed to slightly reduce the nation’s outstanding debt-to-GDP in 2017 (see chart above), debt deleveraging has had other consequences, like hurting the ability of small businesses to raise the capital they need to grow.
Lessons from a visit to the temple
My wife recently took a trip to Xiamen, in the Fujian province of southeastern China, where she hopped on a short plane ride to Zhoushan. There, she joined thousands of other tourists and locals who prayed in the temples of Mount Putuo, which is one of the four sacred mountains in Chinese Buddhism.
She’s been visiting the temples at Mount Putuo for four straight years. Each time she’s came back, there was something new she hadn’t seen before.
At the busy Port of Shenjiamen, before a short 15-minute boat ride to Mount Putuo, there was a new Starbucks opened two years ago. This year, there was a brand new Kentucky Fried Chicken restaurant. There were also modern toilets (a big relief to most non-Chinese visitors).
This time, however, she noticed that foot traffic was particularly light in the famous pilgrimage spot. There were also a lot of empty seats on the plane from Xiamen. It was crowded around the same time last year.
When she asked the tour guide about the thinner crowds, he replied that tourism in the area is down by half because of “a bad economy”.
When an economist sitting behind a desk in an office all day says the economy is doing poorly, I tend to be skeptical. But when a tour operator who drives around all day, talks to other people in the same line of work and interacts face-to-face with hundreds of travelers says the same thing, it’s worth paying attention to.
So there’s some cause for concern, given slowing GDP growth in China and the worsening trade war.
But Xiamen is a tiny speck in China’s enormous economy. Between 2011 and 2016, its GDP grew 9.2 percent annually to reach US$53 billion. That’s not even half of a percent of China’s overall GDP. So while Xiamen might be encountering some tough times after growing so fast, we can’t generalise that the same thing is happening throughout the country.
China’s middle class is still spending
As we’ve written previously (here), China is in the midst of a structural change in its economy – from one that’s manufacturing and industry-driven, to being increasingly dependent on services like transportation, storage, retail, wholesale, hotels, financial and real estate.
A growing services sector requires a strong and vibrant middle class to drive consumption, as well as demand for real estate and financial products.
For now, China has that. Retail sales were up 8.6 percent in October, despite debt deleveraging and trade war.
E-commerce sales are growing nearly 30 percent a year, and will make up one-fourth of total retail sales in China by 2019. November’s Singles’ Day event, which generated US$30 billion of sales in a day for e-commerce giant Alibaba, and the tens of billions more generated by other online shopping platforms, is a testament to the might of Chinese consumers.
Growth in e-commerce this year is expected to be slower than last year – but only because last year’s growth was so significant (at 39 percent). The law of big numbers dictates that growth eventually has to come down to a more sustainable level.
Also, while China’s corporate debt is high, household debt isn’t. China’s household debt-to-GDP ratio of 49 percent is still low – at par with Hungary and Lithuania, and well below that of Thailand (80 percent), the U.S. (79 percent) and South Korea (169 percent).
So far, debt deleveraging and the trade war is having little impact on consumer spending in China. That might change. But for now, Chinese consumption (from baby diapers to tissue paper, Louis Vuitton handbags to Rolex wristwatches) is still one of the biggest growth stories to take advantage of in the stock market.
Editor, Stansberry Pacific Research