Name – Shashank Agarwala�3^rd Year BBA (Hons.) Finance �Roll – 3-03-16-0069�Registration No. – A01-1112-2299-16�Supervisor – Prof. Basuli Dasgupta

CHINA’S PARAMOUNT DEBT :

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A BUBBLE IN THE BREWING

INTRODUCTION

• China ranks as second largest economy in terms of nominal GDP and the largest economy in the world in terms of purchasing power parity.
• Until 2015, the country was the fastest-growing economy, with growth rates averaging 10% over the period of 30 years.
• The country also has the largest aggregate banking sector assets of $37 trillion (258 trillion CNY) with $26.54 trillion in total deposits.
• China is the largest manufacturing economy, exporter of goods and also the fastest-growing consumer market. It is the second-largest importer of goods.
• It’s found that the reason that China has been getting into a debt problem was mainly due to the huge stimulus package and lax monetary policy during the 2008-2009 global financial crisis.
• It’s estimated that China’s total non-financial sector debt amounted to 235.1% of GDP, a high level relative to other emerging markets, among which public sector debt was 53.2 % of GDP while private sector debt amounted to 181.9 % of GDP..

LITERATURE REVIEW

• EDOARDO CAMPANELLA (2017) “WHY CHINA'S BUBBLE IS A THREAT TO THE GLOBAL ECONOMY” analysed that China’s ballooning corporate debt remains the number one systemic risk to global economic recovery. If the bubble bursts, it will drag down the rest of the world while compromising Chinese premier Xi Jinping’s grip on power ahead of the Chinese communist party congress late in the year. Beijing understands that the debt is hardly sustainable, so over the last two years it has engineered A sophisticated macroeconomic strategy to artificially boost factory prices, increase profits, and ease loan repayments for the most troubled companies. 

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• YUKON HUANG & CIAN YO NOSLER (2014) “CHINA’S DEBT DILEMMA: DELEVERAGING WHILE GENERATING GROWTH” founded that much of the media coverage of china’s economy suggests that the country is headed for a financial crisis. China’s mountain of debt is decried, local government finances are labelled menacing, and A property bubble is called disastrous. But this picture is misleading. While china has serious debt problems, with prudent macroeconomic policies and productivity-enhancing structural reforms, the challenges should be manageable if underlying fiscal issues and growth-related reforms are addressed.

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• YUAN GEORGE SHAN, LEI XU, (2012) "BAD DEBT PROVISIONS OF FINANCIAL INSTITUTIONS: DILEMMA OF CHINA'S CORPORATE GOVERNANCE REGIME", INTERNATIONAL JOURNAL OF MANAGERIAL FINANCE, VOL. 8 ISSUE: 4, found that the state ownership and legal person ownership are negatively related to the level of bad debt provisions, but board size reveals a positive association. Other factors including foreign ownership, independent directors, board meeting, supervisory board size and supervisory board meeting were found to have no impact.

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• LI, WILLETT, ZHANG, (2012) “THE EFFECTS OF THE GLOBAL FINANCIAL CRISIS ON CHINA'S FINANCIAL MARKET AND MACROECONOMY” concluded that the 2008 financial crisis was felt throughout the world, and china was no exception. While china was able to maintain relatively high growth rates throughout the crisis, the negative effects from the crisis on china were considerably stronger than is often realized. Between 2005 and 2007, china’s stock market increased fivefold, but starting in October 2007, the stock market in china crashed, wiping out more than two thirds of its value.

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RESEARCH GAP

• China’s debt structure has been a reason of concern for everyone. All the previous literature have shown the trends of the risk associated with the debt structure. China has been in the list of all the analysts with a negativity attached when it comes to the authenticity of the economic figures. Shadow Banking has been the major reason for the concern and non-reliability.

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• This paper aims to analyse how China’s Debt along with the economic slowdown fuelled by the policies can lead to a financial bubble based on data computed and forecasted by independent authorities.

OBJECTIVE OF THE STUDY

• To understand how debt flows in inter-sectoral channels of China’s economy.

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• To understand the debt structure of China.

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• To analyse the economic slowdown and its implications on China.

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• To analyse the potentiality of a bubble development in China.

RESEARCH METHODOLOGY

• Nature of Research – Descriptive and Analytical
• Data Type – Secondary Data
• Data Source – The data for study has been collected from various sources:

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• Books
• Articles
• Journals
• Internet sources

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• Period of Study – 2010 - 2016~2019

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• Research Tools - Bar Graphs, Pie-Charts, Line Diagrams.

ANALYSIS & INTERPRETATION

Basis of Analysis –

• Leverage of Non-Financial firms
• Growth of Assets
• Bank risk taking.
• Credit spreads.
• Household debt.

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SHADOW

BANKING

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Shadow banking is an unregulated and unstable aspect of the Chinese market which sells anything from wealth-management products to investment trusts — creating a notion of an expanding economy beyond official channels.

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According to the Centre for Strategic and International Studies, state-owned enterprises accounted for more than half of China's corporate debt in 2016, while only accounting for half of its GDP.

SOURCES OF FUNDING FOR SHADOW BANKING LOANS

DEBT FLOWS IN INTER-SECTORAL CHANNELS

Leverage of non-financial firms

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• The situation worsens by the government’s role of acting both as a lender and a borrower resulting in concentration rather than dispersion of credit risks.
• Local government debt will need to be cleaned up at some point, which will exacerbate banks’ asset quality.
• As Elmendorf and Mankiw (1999) argue – The Deficit Gamble, a heavy debt burden could weigh on growth rate both in the short and long term.

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CHINESE DEBT, BY SECTOR (% OF GDP)

DOMESTIC NON-FINANCIAL SECTOR DEBT

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

DEBT STRUCTURE

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YEAR ON YEAR CREDIT GROWTH RATE

An existing debt burden on the economy can worsen the situation of the economic slowdown.

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China , in this case, with lowering GDP growth rate and YOY credit growth rate increasing where the latter is 3 times the base value of the GDP. This, itself sets an alarm.

GROWTH RATE OF REAL GDP

ECONOMIC SLOWDOWN

• Even the interest to debt on the industries fall in the gloomy side when it comes to quantification by performance.

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• Leading sectors which drive the economy like matals,capital goods,chemicals etc are agaist the healthy direction.

INTEREST – DEBT RATIO

� Growth Of Assets��The crude steel production which chunks a major area of the economic driver also started falling and at constant stage with reduced profitability. ��The overall infra sector is hardly hit with minor reductions in others which shows the high possibility of a bubble.�� Such a drastic fall within a period of less than 18 months shows high levels of instability and discontent with high degree of over saturated utilisation.

FIXED ASSET INVESTMENT BY TYPE, ANNUAL % CHANGE

CRUDE STEEL PRODUCTION

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

A comparative study between China & USA shows the indexation of the respective financial markets to overall markets.���While the largest economy and overall worldwide trend show a slump in the index, china goes aggressive when it comes to the indexation with high degree of fluctuations. ���This poses huge risk for both the domestic economy as well as the globalised setup.

CHINA’s FINANCIAL SECTOR RELATIVE TO OVERALL MARKET

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U.S.’s FINANCIAL SECTOR RELATIVE TO OVERALL MARKET

2010 2011 2012 2013 2014 2015 2016 2017 2018

Bank risk taking.

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��The trend of the credit intensity shows that the post 2008, the need of an credit infusion was of utmost importance. ����The Guardian (August 15 2017) noted, “China needed three times as much credit in 2016 to achieve the same amount of growth as in 2008”. ����With this trend, the economic prosperity and viability endangers itself keeping in consideration- global economic slowdown and exhausting domestic investment sectors�

CREDIT INTENSITY

• It is not possible to determine how the central government would react to local government insolvencies on a systemic level even if it now strives to stop the uncontrolled lending to LGFVs going on. Judging by these coherencies, it seems mandatory to employ an “augmented debt” scenario for the calculation of central government debt.

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• In August 2017, 68.1 percent of GDP was augmented government debt. Some non-government activity might be included and that some funds and LGFVs “may end up having substantial revenues” carries with it a slight hint on the broad scope and reasons for introducing the “augmented debt” scenario in the first place.

RISING AUGMENTED DEBT

percent of GDP

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

Credit Spread

• High savings rate with reduced consumption can be seen.

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• Domestic consumption, which had been the driving force for the economic growth post sub-prime crisis is declining amidst global economic slowdown.

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• With high rate of savings and lowering consumption parallel to high debt can prove fatal for the economy.

SAVINGS AND CONSUMPTION (IN % OF GDP)

IMPLICATIONS

Other than coal, all the major industries show a decline in the utilisation rate. This is so because coal mines produced over legal designed capacity in the earlier years.��The domestic utilisation worsened in all other cases due to overcapacity. Though the global market share is dominated by china, its share of investo-return scenario seems dull.��Also, the situation worsened when the nationwide utilisation rate fell below the estimated ones. ��This proves a holistic approach of how the industry and economy is suffering from the over investment and its ability to extract the required returns.

OVERCAPACITY : DETEREORATING UTILISATION & LARGE GLOBAL SHARE

2010 2016

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2010 2016

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2010 2016

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2010 2016

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2010 2016

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2010 2016

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2010 2016

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HOUSEHOLD DEBT Y-O-Y GROWTH

RESIDENTIAL HOUSING GROWTH

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Household Debt

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China's rate of private property ownership with over 89.68 percent of households owning an own house or apartment has grown to be among the highest in the world. It has risen up from close to zero only two decades ago. This shows the immense wealth creation but the Y-O-Y growth has been mounting up and the figure now reaches close to 46.3%.

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Similarly there is a fall in the in demand and price of floor spaces on an Y-O-Y basis when it comes to residential housing growth. So, it makes it a troublesome situation when it comes to the contrasting scenario between the two.

• China, known as the dominant player for manufacturing is also facing fall in employment.
• Adoption of technology is the prima-facia reason of declining Industrial employment.
• Avg. age is increasing, which also gives rise to the fall in demand of a major chunk of workforce.
• Reduced employment will put additional burden on the economic cycle of investment and consumption, squeezing the consumption cycle further.

EMPLOYMENT BY SECTORS

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

MAJOR FINDINGS

• State-owned enterprises accounted for more than half of China's corporate debt in 2016, while only accounting for half of its GDP.
• Government is concentrating credit risk by acting both as a lender and a borrower.
• GDP growth rate is more than twice Y-O-Y credit growth rate.
• Major industry sector is performing poorly.
• Capital assets are slowing down rapidly.
• Banks are playing a highly risky leverage.
• Credit intensity is rising alarmingly.
• The debt is rising with no slowdown in its growth.
• China’s domestic economy is saturated & overall global market share is falling.
• Household debt piles up high whereas housing growth experiencing a slump.
• Falling trends in the major employment sector.

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CONCLUSION

• A lot of the country’s debt can be bad debt.
• Shadow Banking can be troublesome for the domestic economy.
• Its not just a debt crisis on its own but it's the fear of debt crisis reducing consumer confidence, business confidence.

RECOMMENDATION

• Recognising companies in financial problems(triage).
• Loss identification and financial restructuring.
• Corporate restructuring.
• Facilitating entry into the market.
• Tightening budget constraints.
• Improving local authorities’ fiscal discipline.

LIMITATIONS

• Lack of proper institutionalised data.
• The data provided are by expert opinions.
• China doesn’t release its actual figures to the official numbers .
• A proper econometrics model for computation would be most suitable.

BIBLIOGRAPHY

• https://mpra.ub.uni-muenchen.de/68548/1/MPRA_paper_68548.pdf

• https://www.ft.com/content/0c7ecae2-8cfb-11e8-bb8f-a6a2f7bca546

• https://www.cnbc.com/2018/10/16/china-hidden-local-government-debt-could-be-6-trillion-sp.html

• https://www.forbes.com/sites/panosmourdoukoutas/2018/11/24/debt-not-trade-war-is-chinas-biggest- problem/#5879cbe64c4d

• http://www.cadtm.org/An-Overview-of-Chinese-Debt

• https://www.bloomberg.com/quicktake/chinas-debt-bomb

• https://www.imf.org/external/pubs/ft/wp/2016/wp16203.pdf

• https://www.statista.com/statistics/263616/gross-domestic-product-gdp-growth-rate-in-china/

• https://www.ceicdata.com/en/indicator/china/domestic-credit-growth

• https://tradingeconomics.com/china/loan-growth

• https://data.oecd.org/gdp/nominal-gdp-forecast.htm

• https://safehaven.com/markets/emerging-markets/What-Happens-When-Chinas-Debt-Bubble- Explodes.html

• https://www.thebalance.com/how-would-china-s-slowdown-affect-the-global-economy-1979076

• http://fortune.com/2016/11/02/china-housing-bubble/

• https://www.tutor2u.net/economics/blog/evaluate-the-consequences-for-the-global-economy-of-the-chinese-economic-slowdown

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