China’s leverage not a problem if it’s sustainable

Source:Global Times Published: 2018/11/19 19:08:40

Illustration: Luo Xuan/GT

China's non-financial sector - the government, households and non-financial businesses - reported low, stable leverage ratios before 2008. When the global financial crisis arrived in 2008 and hit China, the country announced a 4-trillion-yuan ($577.88 billion) stimulus plan. The injection of new bank loans rapidly drove up debt ratios, and the central government decided in 2015 to curb the rise in leverage. This effort started producing effects in 2017 and has continued to be effective this year.

The sudden rise in Chinese household debt in 2009 was partly due to an increase in purchasing of homes as well as travel and other forms of consumption, all based on borrowed money. This drove up household leverage significantly.

The pursuit of deleveraging in the financial sector has produced results. But in light of the correlation between finance and the real economy, if the financial sector moves too hastily in its deleveraging efforts, the real economy will run out of money, causing unstable cash flows and liquidity shortages, and this will lead to an economic slowdown.

The leverage ratio for the central government and local governments has also been on the rise, but not at a particularly rapid pace. Local governments saw a rapid increase in debt in 2014 before moderating in 2015 when local government fundraising vehicles were recategorized as businesses. This meant that loans previously considered as local government debt were changed into corporate debt.

Deleveraging is no easy task and the country needs to take a comprehensive approach to it.

China's debt problem mostly revolves around the corporate sector. More specifically, there are still loss-making "zombie" companies among China's State-owned enterprises (SOEs). 

Local governments have heavy responsibilities, but insufficient financing prompts them to rely on land sales. If there is not much room for land sales, local governments will borrow instead. Therefore, local government debt is an institutional issue. There ought to be measures to address the problem - the relationship between the government and the markets needs to be clarified, and local governments require clarifications regarding their duties, responsibilities and fiscal autonomy.

Deleveraging is essentially about handling risks. The core problem with deleveraging is the nonperforming loan issue. If a lot of the loans turn out to be good debt, the leverage is not a problem. But if the debt incurred fails to yield an increase in value or can't be sold off, it is necessary to deal with the risks and fork out money to buy nonperforming assets.

Additionally, efforts are needed to enhance supervision over the asset management industry. As leverage has increased, a large amount of money has moved beyond banks' balance sheets. Many companies have also been banking on fintech to tap into financial services that involve fairly high leverage. This must also be dealt with.

Macro leverage derives mostly from currency issuance, so the key to deleveraging is reining in money supply. Consequently, it is one of the country's established goals to maintain a prudent monetary policy.

It needs to be remembered that leverage is not supposed to be got rid of completely. Loans must be paid off slowly to avoid killing the goose that lays the golden egg. Leverage activities constitute the entire groundwork for financial operations; the key is to make it sustainable.

The country's leverage has often been shown to be unsustainable in recent years, with evidence of excessive interest payments. I would argue that the deleveraging process should not focus just on reducing borrowing, but also on lowering financing costs for companies. Lowering costs in terms of interest rates, the tax burden and various institutional costs facing companies is part of this year's structural reform program. The economy won't perform well if businesses are suffering.

Deleveraging is a financial issue, and a comprehensive arrangement is required for it to be addressed. That suggests a push for SOE reforms and an improvement in the business climate to put privately owned businesses on an equal footing with SOEs. Furthermore, market-oriented principles should be upheld, and recategorizing debt must therefore be avoided. Deleveraging should also be ruled by the law. That way, the country's deleveraging will surely succeed.

The article was compiled based on a recent speech by Li Yang, director-general of the National Institution for Finance and Development under the Chinese Academy of Social Sciences.


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