China’s Debt Levels Threaten to Spark a Crisis Bigger than the U.S. and Euro

There are a growing number of reports from around the world alluding to the high levels of debt permeating the Chinese economy, and now, world leaders and prominent economists are sounding the alarm. Ratings company Fitch has estimated that the overall debt burden in China is 74 percent of GDP, placing in the red zone of sovereign debt to GDP ratios. The problem is compounded by the notorious unreliability of Chinese reporting, and observer wonder if its just the tip of a much bigger iceberg that is actually visible at present.

For example, Xiang Huaicheng, a former finance minister in China, said at a forum that local debts may total 20 trillion Yuan, which in addition to official debt, suggests a debt-to-GDP ratio closer to 85%.

In a Thursday column for the South China Morning Post, Hu Shuli urged local governments in China to open their books and reform their financial structure to avoid a crisis:

The extent of the risk from local government debt has been a topic of hot debate. It is hard to tell when, where and how it could destabilise the system, given the opacity of government operations. Some analysts are worried about the sluggish growth of government revenues. Meanwhile, many people both in and outside the government believe the risk of default is low because the central government would pick up the pieces if things go wrong.

This view is mistaken. The central government is not obliged to guarantee local government debt.

Besides, with the economy slowing and the growth of fiscal revenue also easing, the central government may in fact have no ability to bear the burden of debt in case of a systemic meltdown. The debt will instead be monetised, and the people will have to foot the bill. This is China’s own subprime mortgage crisis in the making.

According to some insiders, Chinese banks are already in serious trouble.

Larry Lang, a Hong Kong-based economist, warned back in March that the fuse of China’s ‘debt bomb’ had already been lit, and that it was just a matter of time until ‘everything goes bang’.

Besides the official debt numbers in the United States, businesses throughout China have become much more dependent on the nation’s ‘Shadow Banking’ sector, which consists of non-bank financial services entities. According to Lang, “The shadow banking system is preferred by many local businesses, real estate, and manufacturers, and has 30 trillion yuan ($4.8 trillion) worth of loans in the market.”

Senior figures such as Xiao Gang, former chairman of Bank of China who was recently promoted to head of the main regulatory watchdog CSRC, have warned of a potential “Ponzi scheme” in these developments. He was especially referring to the growth of so-called wealth management products (WMPs), which have gone viral in the last 3-4 years, since the stimulus programme. The value of outstanding WMPs rose to 13 trillion RMB (US$2.1 trillion), or 16 percent of total bank deposits in 2012, which is an increase of 50 percent from 2011. These are risky financial instruments that hardly anybody really understands. So, you get that déjà vu feeling, remembering how this sort of financial hocus pocus became rampant in the US a decade ago, prior to the banking collapse of 2008.

A top Chinese auditor and head of the country’s accounting association says the debt party needs to end.

Speaking to London’s Financial Times, Zhang Ke Hoc says he now refuses to sign off on risky bond sales by local governments already up to their necks in debt. “Most don’t have strong debt servicing abilities. Things could become very serious. It is already out of control. A crisis is possible, but since the debt is being rolled over and is long term, the timing of its explosion is uncertain,” he said.

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