The China Debt Crisis Is Still Ripening

By Nathaniel Taplin


Rising Chinese bond and money-market yields—both of which have touched their highest levels in more than a year over the past six weeks—are haunting Western investors with memories of crises past.

Such market trends in China and the country’s continuing debt pileup are worrying. Still, China is at a different place in the economic cycle now than the U.S. was back in 2007. For now, China’s corporate sector, where China’s debt problem is concentrated, is seeing revenues grow at their fastest pace since 2011 while real borrowing costs are falling.

The U.S. economy was at a different point when the global financial crisis struck. U.S. mortgage debt had built up for years in the mid-2000s, but mortgage-backed securities didn’t start torpedoing the financial system until mid-2007. Employee income growth had peaked cyclically in 2005, but the Federal Reserve kept raising interest rates for more than a year afterward—pushing mortgage borrowers ever deeper into the hole until the weakening labor market finally pushed debtors over the edge.

In China, the central bank began tightening policy relatively recently. Meanwhile, factory gate inflation is at a six-year high, which means real borrowing rates have fallen rapidly. Producer price-adjusted one-year lending rates, which were as high as 10% early in 2016, have now fallen below zero. Listed materials firms’ average earnings more than doubled in the first quarter of 2017 according to Wind Info, while overall industrial revenues were up 14%.

This can’t last forever. Already, a big rebound in “shadow finance,” primarily bank-mediated company-to-company loans, is papering over the cracks in China, blunting the impact of the tighter corporate bond market. While corporate bond debt outstanding fell by 58 billion yuan ($8.4 billion) in the first quarter of 2017, shadow finance ballooned by more than 2 trillion yuan, nearly twice as much as in the fourth quarter of 2016. Growth in total financing for firms and households, including local government bonds, has barely slowed—it rose 16% in early 2017, versus 16.8% in the fourth quarter of 2016.

Chinese firms are still borrowing heavily and the Chinese banks backing them continue to rely heavily on risky interbank funding—eventually both firms and banks will need to pay the piper, or Beijing will need to absorb much more debt itself.

But as in the U.S., the breaking point is more likely to come when borrowers start feeling the pinch from slowing incomes and higher real borrowing costs. If the Chinese real-estate sector and inflation surprise on the downside later in 2017, or the dollar and rapid capital outflows bounce back, the piper could come knocking quicker than expected.

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