A spate of recent commentary has been warning of the vertiginous rise in China's debt, which jumped from 148 percent of GDP in 2007 to 249 percent at the end of the third quarter of 2015. Many are anxiously pointing out that China's debt is now comparable to that of the European Union (270 percent of GDP) and the United States (248 percent of GDP). Are they right to worry?
To some extent, they are. But while observers' concerns are not entirely baseless, it is far too early to sound the systemic-risk alarm. For starters, China has a very high savings rate－above 45 percent over the last decade, much higher than in the advanced economies－which enables it to sustain higher debt levels.
Moreover, China's banking system remains the primary channel for the deployment of the household sector's savings, meaning that those savings fund corporate investment through bank lending, rather than equity financing (which accounts for only about 5 percent of net investment). Indeed, the sharp acceleration in the debt-to-GDP ratio is partly attributable to the relative underdevelopment of China's capital market.
Once these factors are taken into account, China's overall debt levels do not seem abnormally high. While debt might be a problem for Chinese companies with excess capacity and low productivity, companies in fast-growing, productive sectors and regions may not be in too much trouble. More generally, China has made recent progress in boosting labor productivity, encouraging technological innovation, and improving service quality in key urban areas, despite severe financial repression and inadequate access to funding by small and medium-sized private enterprises.
Of course, China's debt is still rising－a trend that, if left unchecked, could pose a mounting threat to financial and economic stability. But the structure of China's national balance sheet suggests it still has plenty of room to mitigate the risks that escalating debt might bring.
Thanks to China's high savings rate, its banking system had a loan-to-deposit ratio of 74 percent at the end of 2015, with 17.5 percent in required reserves held at the central bank. The capital adequacy ratio was as high as 13.2 percent. Given that China's net external lending position amounts to $1.8 trillion, or 17.2 percent of GDP, the central bank has enough liquidity to reduce banks' reserve requirements without resorting to unconventional monetary policy.
Furthermore, after more than three decades of rapid income growth, China has accumulated wealth (or net assets) in almost all sectors. By any standard, China's household sector has very low leverage, with a debt-to-deposit ratio of 47.6 percent. Even the corporate sector's leverage is not as high as many reports suggest. Household deposits accounted for 40.1 percent of total bank deposits of 146.5 trillion yuan ($22.5 trillion) at the end of March 2016, while non-financial corporations comprised 32.1 percent and the share of government deposits was 17.1 percent. The combined debt-deposit ratio of the non-financial corporate sector and the government sector was 97.6 percent, which means these sectors' total deposits exceeded their debts to the banking system by 1.7 trillion yuan.
In addition, the Chinese Academy of Social Sciences estimates that the central and local governments have accumulated net assets of nearly 146 percent of GDP, mostly in real estate. In short, while China has a problem with inefficient capital allocation, it is nowhere near a solvency or liquidity crisis.
Giacomo Corneo of the Free University of Berlin has proposed that, in addition to taxing underused real estate, China should create a sovereign wealth fund to improve the management of public assets. Given that those assets amount to an estimated $18 trillion, a higher return on capital would boost GDP and reduce debt. China's bank regulators have already permitted experiments in debt-equity swaps, which the International Monetary Fund says should be incorporated in a comprehensive strategy to accelerate the reform of State-owned enterprises.
China has the savings to address its growing debt burden. Amid slowing growth, however, its window of opportunity is narrowing. The sooner China rebalances from debt to equity, the better off it will be.
About the authors: Andrew Sheng is distinguished fellow of the Asia Global Institute at the University of Hong Kong and a member of the UNEP Advisory Council on Sustainable Finance, and Xiao Geng, director of the IFF Institute, is a professor at the University of Hong Kong and a fellow at its Asia Global Institute.
