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Moving From Debt to Equity in China

HONG KONG – A spate of recent commentary has been warning of the vertiginous rise in China’s debt, which jumped from 148% of GDP in 2007 to 249% 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% of GDP) and the United States (248% 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. As a recent HSBC report points out, the reasons for China’s rapid accumulation of debt, which is concentrated in the corporate and local-government sectors, suggest that the situation is not nearly as dangerous as many are making it out to be.

For starters, China has a very high saving rate – above 45% 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% 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-size private enterprises.