Why is China being penalized for its debt problem, but advanced economies aren’t?

Today, rising debt is one of China’s key challenges. Recently, it led to the mainland’s rating cut by ratings agencies. Yet, many advanced economies have higher credit ratings than China, though their leverage ratios are worse.

In May 2017, Moody’s Investor Service downgraded China’s credit rating. In September, Standard & Poor’s, too, cut China’s credit rating, citing the risks from soaring debt.

Interestingly, S&P revised China’s outlook to stable from negative, although rating cuts usually go hand in hand with more negative outlook.

Like major advanced economies, China has now a debt challenge. Yet, the context is different and so are the implications.

Drivers of China’s leverage

In 2008, at the eve of the global crisis, China’s leverage – as measured by a ratio of credit to GDP – was 132 percent of the economy. Even in 2012, it was still barely 160 percent. Yet, today, it amounts to 258 percent of the economy and continues to soar. In relative terms, that’s almost twice as high as in 2008. Why has Chinese debt risen so rapidly?

Historically, the increase can be attributed to two surges. The first was the result of the $585 billion stimulus package of 2009, which supported the new infrastructure but also unleashed a huge amount of liquidity for speculation. Today, the latter is reflected by China’s excessive local government debt (whereas central government debt remains moderate).

Another sharp surge followed in 2016, which saw a huge credit expansion as banks extended a record $1.8 trillion of loans. It was driven by robust mortgage growth, despite government measures to cool housing prices. As a result, credit was growing twice as fast as the growth rate.

China’s leverage is likely to continue to rise to 288 percent of the economy by 2021. Nevertheless, the debt-taking is now slowing, which suggests that the central government’s effort to deleverage corporates has started to bite – already before the 19^th Party Congress.