China’s Corporate-Debt Challenge

WASHINGTON, DC – The Chinese economy has slowed in recent years, but it is still a strong performer, contributing about one-third of total economic growth worldwide. It is also becoming more sustainable, in line with the shift in its growth model away from investment and exports and toward domestic demand and services.

In the run-up to next month’s G20 summit in Hangzhou, China has been calling loudly for new commitments to structural reforms to stimulate growth in advanced and emerging-market economies. But China faces serious risks at home. Above all, domestic credit continues to expand at an unsustainable pace, with corporate debt accumulating to dangerous levels.

According to the International Monetary Fund’s recently published annual report on the Chinese economy, credit is growing about twice as fast as output. It is rising rapidly in both the non-financial private sector and in an expanding, interconnected financial sector that remains opaque. Moreover, while credit growth is high by international standards – a key indicator of a potential crisis – its ability to spur further growth is diminishing.

Warning signs are flashing, and the Chinese government has acknowledged the overall problem. But, to avoid a crisis, it should immediately implement comprehensive reforms to address the root causes of the corporate debt problem. These include soft budget constraints for state-owned enterprises (SOEs) and local governments, implicit and explicit government guarantees of debt, and excessive risk taking in the financial sector – all of which have been perpetuated by unsustainable official growth targets.