The extraordinarily rapid rise of debt in China, particularly in the corporate sector, has given rise to fears that the country may be unable to avoid a banking crisis that would slow its growth and have substantial negative spillovers on the global economy. This fear is based on recent estimates by the International Monetary Fund and some investment banks that a substantial portion of new lending in recent years has gone to state-owned companies producing oversupplied goods where profits have turned -negative.
In fact, while lending more to corporates unable to pay interest and principal on previous loans means financial risks are clearly rising, it is likely that China is years away from a potential banking crisis, providing it with a window to slow the growth of credit to a sustainable level. A key reason for this judgment is that while the ratio of debt to gross domestic product is quite elevated, China also enjoys a high rate of national savings. The level of debt a country can sustain depends significantly on the share of domestic savings in GDP.
Second, China’s debt build-up is almost entirely in domestic currency. Local companies have been paying down their foreign currency debt since the third quarter of 2014 and it now accounts for only 5 per cent of domestic debt. In contrast, a recent study of other emerging markets found that the median foreign currency debt as a share of total debt is four times the Chinese share. Moreover, China remains a large net creditor to the rest of the world. Thus, the country is not vulnerable to a financial crisis such as the one in Asia in 1997, which was precipitated by a refusal of foreign lenders to roll over their credit to Asian corporates.