The Danger in China’s Dual Debt Cycle

Cleaning up ballooning debt will strain the financial system, and ordinary consumers will feel the pain

By Anjani Trivedi


Predicting the evolution of corporate debt cycles is always tricky. In China it’s doubly hard—because there are two cycles in process.

Most concern about the speedy rise of credit across China’s economy is focused on the sheer scale of corporate leverage, now close to 166% of GDP. Less noticed is that parallel debt cycles in the public and private sector are running at different speeds.

It means that as Beijing attempts to rein in mushrooming risks by raising borrowing costs, it must contend with two balance sheets—one for state-backed companies, accounting for over half the credit in the system, and the other for private companies, accounting for about a quarter. Data from Deutsche Bank suggests that private companies’ debt problems are being cleaned out quicker—over the past five years, about 13% of all their loans have been deemed nonperforming. The ratio for state-owned firms is just 1.3%.

The two-track cycle is of Beijing’s own making. While struggling state-owned companies have been kept afloat by their state banking peers, weak private companies have been forced to refinance at higher interest rates. Some have tapped shadow banking; others have closed down altogether. One corollary is a pileup of unproductive debt: Evergreened credit—loans, mostly to state-owned firms, to pay off older debts—now amounts to almost 9% of all credit, according to Deutsche.

Cleaning all this up will strain the financial system. China’s banks have been the main financiers and will surely have to suffer more. But it’s also likely that much of the bill wall fall indirectly onto ordinary Chinese consumers.

A rising portion of the credit is being provided by the shadow-banking system through a ballooning number of new forms of finance—like peer-to-peer loans and wealth-management products wrapped in other-wealth management products—sold to retail investors eager for higher returns for their trapped household savings.

These wealth-management products, along with China’s national social security funds, provided around 80% of the funding in the debt-to-equity restructuring of state-backed Wuhan Iron & Steel. As China works through its debt problems, there will likely be more such episodes. As the process grinds on, it seems likely that Beijing will once again rely on the Chinese people to bear the brunt.

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