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Pro-Growth Policies Won't Induce a Debt Crisis
By Xu Gao | NO. 20 MAY 19, 2016



Some have expressed concern that the domestic debt level may rise as a consequence of policies aimed at stabilizing economic growth. Such concern seems reasonable given that China relies primarily on investment, which is supported by debt financing, to shore up growth. 

According to an estimation by the Chinese Academy of Social Sciences (CASS), the combined debt of households, enterprises and the government stood at 236 percent of China's GDP in 2014, more than 60 percentage points higher than in 2007. As economic growth slows and the return ratios of investment decline, rising debt levels seem to pose great risks. 

Nevertheless, there is no direct correlation between high debt levels and a debt crisis. Spain's debt-to-GDP ratio was only 70 percent in 2011, even lower than Germany's at the time, but a debt crisis still occurred. In contrast, the current debt-to-GDP ratio of Japan is nearly 250 percent, yet there is no sign of a crisis. 

Whether our pro-growth policies will trigger a debt spiral or not requires careful analysis. Evaluating the current economic climate, there is no present risk of such a crisis and no need to worry about these policies.  

First, both assets and debt should be considered when assessing debt sustainability. In recent years, asset growth has kept pace with debt accumulation, thus China's debt-to-asset ratio has remained largely stable. According to the CASS estimation, the debt-to-asset ratio of the household sector was less than 10 percent in 2014, compared to 40 percent for the government; and the 60-percent ratio for non-financial companies was still lower than the 2000 level. Therefore, China's balance sheet and the balance sheets of multiple sectors are healthy. 

In reality, foreign debt is most likely to trigger a crisis. For instance, the European debt crisis was caused by mounting foreign debt from EU countries. However, according to its International Investment Position statistics, China still had $1.6 trillion of net foreign assets after deducting foreign debt. Moreover, as most foreign assets held in China are in the form of foreign exchange reserves, it has superior liquidity to foreign debt primarily in the form of foreign direct investment. Consequently, China's foreign debt levels are reasonable.  

The enormous level of domestic savings constitutes a solid foundation for China's debt sustainability. Some critics say that China has a low rate of consumption, which accounts for less than 40 percent of GDP, and a high debt level. However, they ignore the link between consumption and debt. Indeed, low consumption leads to a higher savings ratio--China's gross national savings account for nearly half of GDP. Eventually, household savings will be spent or invested in other forms. As China's stock market is underdeveloped, with stock financing accounting for less than 5 percent of overall finance in the last decade, savings are mostly transferred into corporate investment through bank lending. This causes total debt to rise. 

Multiple reasons explain China's high savings ratio. Households' property income remains low; the underpowered social security system prompts residents to save for a rainy day e.g. illness or old age, and high housing prices have also played a role in curbing spending.  

The government has taken a series of measures to boost consumption, but these have had no obvious effect. The high savings ratio will continue. If the savings are not effectively transferred into investment through bank lending, the Chinese economy will decline due to inadequate demand. 

As foreign demand shrinks owing to the global financial crisis, China must transform huge domestic savings into demand through lending in order to catalyze growth. From this perspective, high debt levels have effectively been counterbalanced by high savings and there is maneuver room for increased debt, which is essential. 

In a nutshell, China will not suffer a debt crisis as a result of pro-growth policies. The rise of domestic debt is necessary and measures to stabilize growth should not be abandoned out of fear of a debt crisis. 

This is an edited excerpt of an article published in Economic Information Daily. The author is chief economist of Everbright Securities Co. Ltd.

Copyedited by Dominic James Madar 

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