IMF’s China debt alarm downplayed

The huge corporate debt in China that makes headlines is more complicated than most people think, according to the top Chinese official at the International Monetary Fund (IMF).

Jin Zhongxia, executive director for China at IMF, said the rapid increase of corporate debt in China during a period of time needs to be properly analyzed, citing recent discussions in China regarding the nature of the country’s corporate debt.

“Some believe that some part of the corporate debt actually is debt issued by the local government established entities,” Jin told the IMF executive board on Wednesday during a discussion of the IMF report Financial Sector Assessment Program (FSAP) for China.

In an online press briefing on Wednesday evening, Ratna Sahay, deputy director of the IMF Monetary and Capital Markets Department, called China’s looming debt a major risk in its financial system.

She described the sustained credit expansion as being of a magnitude that in other countries has been associated with financial distress. “This has resulted in high corporate and local government debt. And household debt is also rising at a fast pace,” she said.

The IMF cited the rapid credit growth as a result of China’s focus on maintaining economic and employment growth.

The IMF report noted that this debt is largely owed by companies — some of which may not have good prospects — and local governments, but an increasing share is owed by households.

“Credit growth is an important indicator of future financial distress, because lending standards often fall in the rush to make more loans,” the report said.

According to Jin, the purpose of raising the debt by local government entities is to fulfill their responsibility to implement urbanization and infrastructure development.

“In China, the local governments take a lot of responsibilities, but their ability to mobilize resources through taxation or bond issuance is limited,” he said.

“In that case, part of the corporate debt is actually local government debt,”

Jin believes it is necessary to revise down the corporate debt ratio and increase local government leverage ratio accordingly.

“The official public sector’s debt over GDP is quite low, only 40 percent. “If you add the hidden local government contingent debt, that may increase the total public debt over GDP ratio, and the corporate sector debt will decrease by the same amount,” he said.

“In the end, what really matters is the total leverage ratio in China, which includes the government debt, corporate debt and the household debt”, he said.

The total leverage ratio in China is 260 percent of GDP, which is still lower than most of the advanced countries and is comparable with many emerging-market economies, according to Jin.

Sahay admitted at the press conference that there has been some effort in measuring the debt more carefully, and the IMF is revising the numbers. “So this part of the corporate debt will be attributed to the local government,” she said in response to China Daily.

Yukon Huang, a senior fellow at the Carnegie Endowment for International Peace, has long expressed the view that China’s debt problem deserves concern but is overstated.

Huang, a former World Bank country director for China, has acknowledged the role played by many established local government entities. He also has said that a lot of the credit has been funding the increased value of land and property, and if these property values are stable, the increase in credit is not an issue.

“Property prices in China are probably OK, which means there isn’t a major debt problem,” said Huang, author of the book, Cracking the China Conundrum: Why Conventional Economic Wisdom Is Wrong.

The IMF’s FSAP report for China also pointed out the complexity of China’s financial system by saying that rules on bank lending to traditional sectors, such as construction and real estate, have pushed risky borrowers away from banks and toward more lightly regulated financial products.

The IMF claimed that banks often compensate investors for losses on financial products to preserve their reputations. It said the Chinese government has repeatedly intervened to stabilize financial markets and investors have come to believe that state-owned enterprises will be bailed out if they get into trouble.

“But protecting investors and companies from losses encourages them to underestimate risk and can lead to a misallocation of investment to less productive economic activities,” Sahay said in an analysis with her colleague James Walsh.

“Taken together, these factors have created a highly dynamic and fast-moving financial system that is very difficult to monitor,” she said.

Some believe that some part of the corporate debt ... is debt issued by the local government established entities.”

Jin Zhongxia, executive director for China at the IMF