China is unlikely to be the centre for the next financial crisis but the increase in local government debt as Beijing allows more borrowings to bolster growth will be a major risk, warned a renowned academic in capital markets in the country.
Professor Wu Xiaoqiu, vice-president of Renmin University of China, said the level of local government debt was close to a “boiling point”.
To arrest a slowing economy, the central government is not only allowing the regions to sell more debt to fund local development, but also granting permission to a few places to sell these bonds to retail investors in a pilot scheme that could further unlock billions of dollars in savings.
Wu said while there were risks in the level of corporate loans, they were not as serious as those for local government debt.
“High debt needs high fiscal revenue and high economic growth, but China’s economic growth has slowed from 10 per cent to 6 per cent. If local government debt continues to increase in the same way, the cost of debt will exceed the fiscal income local governments receives – this means it will be difficult to sustain,” said Wu during a media briefing at the Boao Forum for Asia on Tuesday.
The world’s second-largest economy is growing at its slowest rate in nearly three decades after years of debt-fuelled growth that has become unsustainable. To rectify, Beijing launched a deleveraging drive to rein in excess debt and risky bank lending over the past two years, targeting in particular off-balance sheet lending, also known as shadow banking. The crackdown cut off funding to the private sector, which accounts for 60 per cent of economic growth but is often reliant on informal financing channels because banks prefer to lend to state-owned enterprises that carry an implicit government backing.
Last year, Standard & Poor’s estimated that China’s local government’s off-balance-sheet borrowings could be as high as 40 trillion yuan (US$5.95 trillion), even as the country’s total debt growth, according to investment bank Natixis, slowed to just 2 per cent to 248 per cent of gross domestic product from the 8 percentage point of GDP increase in 2016.
“I have been sceptical [of the deleveraging campaign] since 2018,” said Wu. “It became over-regulation. The real leverage wasn’t in the private sector, but at local governments. The scale of local government debt is massive, which should be the focus of our regulators.”
Beijing instituted a pro-growth strategy in July last year to shore up growth, including allowing extra local government borrowing to fund new infrastructure projects. Since the start of this year, local governments have issued debt totalling 1.1 trillion yuan (US$163.8 billion) through March 24, at least four times the amount raised in the year-earlier period, according to data from private lender China Minsheng Bank.
Last week, the eastern coastal Ningbo city and Zhejiang province began issuing bonds to retail investors. They would be followed subsequently by southwestern Sichuan province, Shaanxi in the north, and eastern Shandong province, as well as Beijing, Xinhua reported.
Still, Wu said he did not believe that China’s debt problem would rise to the scale of the US subprime crisis in 2008 given Chinese banks’ relatively sound assets, even as securitisation grows rapidly in the country.
Securitisation accounted for 4.6 per cent of total Chinese capital market debt issuance in 2018, up from 3.7 per cent in 2017, according to Moody’s. The country is the largest securitisation market in Asia and second behind the US globally, but securitisation is still a relatively small share of debt financing for the Chinese economy, compared with the US and other developed markets, according to the rating agency.
Residential mortgage-backed securities issuance hit a record high in 2018, making it the single largest securitisation asset class and a growing provider of funding for the residential mortgage sector, it said.
“I can say with confidence that a financial crisis as such [US subprime mortgage crisis] won’t happen in China, because China’s financial system is in general healthy and the risk is controllable,” said Wu.
Nor did he think China will drastically devalue the yuan, triggering a large-scale meltdown like the 1997 Asia Financial Crisis, despite a weaker economic outlook and a trade war with the US.
“I don’t think there will be a sharp yuan devaluation in the future, as China’s economic growth is largely driven by its internal demand but not foreign investment,” said Wu.
Wu admitted that China’s relatively subdued risk appetite may have held back the opening up of its financial sector and allowing more flexibility in yuan trading.
“We are pretty cautious about the yuan’s internationalisation. Once it is internationalised and completely free for trading, it means China’s capital accounts will be wide open,” said Wu.
“But we have to evaluate the risks during the process. I reckon it is right for China to be cautious in the opening up of its financial market, although the trend is unstoppable.”
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