S&P Global — 20 June 2024
Daily Update: June 20, 2024
Chinese Debt Decoupling from Economic Growth
By Nathan Hunt
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In the last decade, the Chinese bond market grew to become the second largest in the world after the US. The rapid growth of corporate and government debt is consistent with the needs of the growing Chinese economy. For many years, debt financing was an appropriate way to meet the needs of a growing economy and apply China’s high levels of domestic savings. However, the bond market continues to expand in China without necessarily driving economic growth. There are concerns that the unique features of the Chinese bond market — particularly the outsized presence of local government debt and state-owned enterprises (SOEs) — have made the efficient allocation of capital difficult in the country. A report by analysts from S&P Global Ratings, “China's bond market reforms key to growing with less debt,” looks broadly at the changes in the Chinese bond market.
According to S&P Global, the ratio of nonfinancial sector debt to GDP in China started to pick up around 2007, when the global financial crisis began. That growth shows no signs of slowing. Despite attempts to reduce leverage in China’s financial system, policymakers have been more focused on protecting topline growth by refraining from deleveraging. The growth of debt in China is an outlier compared with other developing markets, but the cohort may no longer represent an appropriate set of peers for the Chinese economy.
During the Chinese economy’s growth phase of the last 25 years, debt financing was an appropriate way to build the infrastructure for rapid industrialization and an urbanizing population. However, the question remains whether infrastructure spending has reached a point of diminishing returns. China’s debt markets have grown, but the share of debt going to corporations has remained largely static, while government debt and the share of credit going to SOEs have increased.
Government spending is an established tool of fiscal policy around the world, but Chinese debt buyers have been taught that local government debt or debt from SOEs are virtually risk-free. This has held back the growth of corporate debt markets, where capital allocations tend to be more efficient and the opportunities for long-term economic growth are more promising. While defaults exist in the Chinese bond market, they remain low compared with the US or EU. This may prevent investors from dedicating capital efficiently.
China’s gross national savings rate is high for a large economy: Savings, which are mostly invested in the domestic economy, account for almost half of the country’s GDP. While a high savings rate is positive for the stability of the Chinese economy, systemic risks could materialize if that capital is deployed toward inefficient investments.
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