The most recent economic data out of China confirms that the country’s economy continues to expand quickly despite ongoing tightening measures by the authorities, writes ALICE BRADER*
Chinese second quarter Gross Domestic Product rose 9.5 per cent from a year earlier, slightly above most economists’ expectations and supporting the view that no hard landing is in store. Nonetheless, recent attention on the debt of Chinese provinces and municipalities has some investors worried a banking/property crisis could derail China’s growth prospects.
Contrary to the increasing fears over European-style national debt problems or American municipal debt issues, the local government debt issue is largely resolvable within China, and hence it does not change the overall positive investment thesis on the country. However, investors should be aware that a sharper-than-expected property sector downturn is a key risk to this hypothesis.
In recent days, Chinese authorities have offered more clarification on the amount of outstanding debt, but confusion and investor speculation are still abundant. Until more concrete details emerge on the size and scale of the problem, as well as details of a realistic mechanism to deal with the indebtedness, volatility in markets will persist. One can therefore merely attempt to put the issue into perspective.
1. The official number from the authorities indicates that the debt of the central government stands at roughly 20 per cent of GDP. Estimates of debt for Local Government Financing Vehicles (LGFV) vary from an additional 15 per cent to 45 per cent of GDP, taking the total debt to anywhere between 35 per cent to 65 per cent of GDP. Comparing some of the highest estimates of China’s debt to other emerging markets, the figure may seem high, however comparing it to other G20 nations such as US, Canada, France, India and even Brazil, it still falls well below debt levels of these countries.
2. An economy can theoretically afford to run a high budget deficit and still see its stock of debt decline as a share of GDP if its GDP is expanding faster than the increase in government debt. Hence, even if one believes that Chinese growth will slow dramatically to 5 per cent a year in the next 10 years, the government could still be running deficits of 3 per cent to 4 per cent (higher than allowed by the EU under the Maastricht rules) and still see its stock of debt to GDP decline from what are already relatively low levels by comparison to the rest of the world.