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China’s debt problems require more attention
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RECENT measures by Chinese policymakers to reduce debt-servicing costs and to make credit more accessible for borrowers is fuelling China’s ongoing credit boom, says Fitch Ratings in a report. The risks of asset quality and liquidity shocks to the banking system will continue to grow the longer that total leverage grows. But Fitch maintains that the likelihood of a full-blown crisis is mitigated by Chinese banks’ strong domestic deposit base and sovereign support.
Fitch expects policy measures fuelling credit growth to continue, with policymakers’ GDP targets suggesting that credit growth will remain strong. These measures include lowering interest rates and bank reserve-requirement ratios, loosening of prudential controls, instructions to roll over loans for highly leveraged borrowers, and bigger roles for the policy lenders. At the same time, the authorities have been reluctant to allow more corporate defaults or for banks to crystallize losses at a faster pace, possibly for fear that sudden interruptions in debt-financing might trigger a credit crunch.
Credit expansion in China continues to outpace GDP growth, causing total leverage — mostly in the corporate and local government sectors — to reach new highs. Fitch-adjusted total social financing (FATSF) to GDP has almost doubled since the 2008 global financial crisis, reaching 243 percent at the end of 2015, and Fitch estimates that it could rise to 253 percent by the end of 2016.
Continued high leverage growth will push back resolution of the banking sector’s asset-quality issues. Fitch views China’s banks as first in line to absorb most of the losses from the build-up of credit, should they become crystallized. Banks will be central to any meaningful resolution of China’s debt overhang. Fitch estimates that two-thirds of FATSF was held directly by Chinese banks as of the end of 2015, and much of the rest is connected to them through the shadow banking system.
It is likely that central government resources will be necessary to supplement banks’ existing means — such as earnings and loss-absorption buffers — to resolve China’s debt overhang. Expectations of substantial losses have impeded the ability of banks to recapitalize themselves through the capital markets alone.
A wholesale carve-out of non-performing assets is possible, as had occurred in the early 2000s, although unlikely to be imminent. However, we do see more debt migrating toward the sovereign balance sheet, beyond that of the local government debt swap programme.
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