Fueled by Long Credit Binge, China’s Economy Faces Drag From Debt Purge
Consumers, businesses and local governments are looking to deleverage
HONG KONG—After years of heavy borrowing, many in China are focused on paying down their debts this year—and the result could be weaker growth for a long time to come.
The world’s No. 2 economy binged for years on credit to finance everything from canyon-spanning bridges to new apartments.
Now China finds itself facing a protracted period of what economists call deleveraging—the painful process in which borrowers divert income to pay down debts instead of spending and investing.
Total credit to the nonfinancial sector was $49.9 trillion last September, more than triple the level 10 years ago, according to the Bank for International Settlements, a consortium of global central banks. But the figure has begun to drop: It is down from $51.4 trillion at the end of 2021.
Total social financing outstanding, a broad measure of credit and liquidity in the economy, expanded by 10% in 2022, compared with growth of 15% in 2017 and 19% in 2012, according to Wind, a Chinese data provider.
The issue isn’t the central government, whose debts are relatively low as a percentage of gross domestic product, but households, the private sector and local governments. Total debt as a share of GDP hit 295% in China last September, surpassing 257% in the U.S. and an average of 258% in the eurozone, BIS data show.
Consumers are hoarding cash, with many refusing to take out loans. Private businesses are barely investing, despite efforts by Beijing to encourage entrepreneurs to spend. Local governments are reducing expenditures on everything from roads to workers’ salaries to get their debts under control.
“Borrowers that are focused on paying down debt are less able to fund new projects that would increase GDP growth,” said Nicholas Borst, director of China research at Seafarer Capital Partners.
Other countries have been through similar processes, almost always painful.
In Japan, the collapse of a real-estate bubble in the 1980s and 1990s compelled corporations and individuals to pay down debt instead of taking out new loans, even after interest rates fell to zero. The ensuing drop in demand led to a vicious cycle of deflation and economic stagnation.
In the U.S., the buildup of subprime mortgage debt in the 2000s helped trigger a financial crisis. That led to years of deleveraging, weighing on consumption and growth.
A study by McKinsey found that in 45 episodes of deleveraging since the Great Depression, 32 followed a financial crisis.
Most economists don’t expect a financial crisis in China, or even a harsh recession, because they assume that the central government has the financial wherewithal and inclination to prevent either.
Economists at Société Générale in a recent report said Chinese policy makers need to learn lessons from Japan and prevent a deleveraging mind-set from becoming entrenched, by restructuring more debts or offering direct income support to households to boost consumption.
If not, the economists warned, China could fall into a trap in which even zero interest rates wouldn’t stimulate growth. “Such a danger seems increasingly relevant for China,” they wrote.
Others think Beijing will tolerate slower growth. Since 2016 it has discouraged off-balance-sheet borrowing by local governments, reined in private conglomerates that were snapping up hotels and other trophy assets overseas, and capped new lending to property developers. That had only limited success restraining debt.
As a result, “the bias of policy will continue to be pushing down leverage wherever they can, even if it causes growth to go lower,” said Arthur Kroeber, founding partner of Gavekal Dragonomics, a research consulting firm.
He estimates that China’s underlying growth rate could slow to 2%-4% in the coming decade, from 6.2% in the past decade and 10.6% in the decade before that.
“The only way to keep China’s growth rate high is to let debts keep growing,” said Michael Pettis, a finance professor at Peking University. “It appears policy makers are choosing a harder constraint on debt.”
Consumers, who Beijing hoped would help drive growth this year, haven’t kept splurging after an initial burst in spending when the government lifted Covid controls late last year.
Despite low interest rates, many homeowners are rushing to prepay their mortgages. Li Si, who bought her first apartment in Zhongshan, a city in southern China, in 2019, said she decided to pay off her mortgage early after losing money investing in mutual funds over the past year. She said felt safer reducing her debt exposure.
“The economy feels far less certain now,” said Li, 33 years old, who works in the financial industry. “What if I lose my job tomorrow?”
Marko Papic, chief strategist at Clocktower Group, a Santa Monica, Calif.-based asset manager, noted that household debt as a share of disposable income is nearing 110% in China, fast approaching where American households were around the 2008 global financial crisis.
“No amount of interest-rate cuts will change the behavior of consumers when they try to deleverage,” he said.
Chinese entrepreneurs, spooked by regulatory crackdowns on the internet and education sectors, are reluctant to assume more risk. Private investments grew by 0.4% in the first four months of this year from the same period last year, compared with 5.5% during the same period in 2019.
Real-estate developers, which once spent heavily buying land from local governments, have cut back dramatically.
Land sales by size in 300 cities fell 26% in the first five months of 2023 from a year earlier, according to the China Index Academy, a property-research institute. It added that most private developers are choosing to repay debt over making new investments.
Then there are local governments, which ran up trillions of dollars in debt in recent years and need to cut spending to avoid default. Local governments and their financing vehicles are on the hook to repay bonds worth close to 7% of China’s GDP, a record, according to Goldman Sachs.