China’s Economy: More Debt than Meets the Eye

Publication: China Brief Volume: 22 Issue: 21

A stand for the Bank of Guangzhou at a financial expo in Guangzhou (source: China Daily)


Since the beginning of this year, investment banks and international financial organizations, including the International Monetary Fund and the World Bank, have steadily downgraded their forecasts for the People’s Republic of China’s (PRC) GDP growth in 2022 to around 3.2 percent (Nikkei Asia, October 7). Most analysts agree that Beijing is in a difficult economic position, but the situation has the potential to become far worse due to off-balance sheet liabilities. Such debt risks defaulting, or may otherwise need to be covered by the central government.

Another drag on the country’s balance sheet that has yet to fully hit home is the impact of Belt and Road Initiative (BRI) financing. Due to economic problems and debt crises in BRI partner countries, a large percentage of the initiative’s loans may have to be forgive or at least restructured. Before looking at its financing and hidden liabilities, it is necessary to establish an overall picture of the current PRC economy across a broad spectrum of indicators.

A Snapshot of the Contemporary Chinese Economy

The PRC has a population of 1.4 billion and a GDP of about $18 trillion (Xinhua, January 17). With a per capita GDP of $11,167 per year, it is an upper-middle-income country (PRC National Bureau of Statistics [NBS], February 28). The Asian Development Bank estimated the nation’s wealth inequality Gini index to be .382 in 2019, the most recent year for which there is data. In the wake of the pandemic, the bank expects this number to rise (Asian Development Bank, August 2021).

Beijing frequently boasts of having lifted 800 million people out of poverty. However, based on the World Bank’s measure of upper-income poverty ($5.50 per day), 13 percent of those within China’s borders still live below the poverty line (South China Morning Post [SCMP], February 24, 2021). Furthermore, the wealth differential between urban and rural residents is significant. Roughly 36.1 percent of China’s population resides in rural areas, where the average disposable income is 18,931 yuan ($2,611) per year, while city dwellers have a disposable income of 43,504 yuan ($6,053) (NBS, February 28; May 11, 2021). As a result of the pandemic, wealth inequality is expected to increase (SCMP, January 23).

Excessive debt is one of the greatest challenges facing the Chinese economy. In September 2021, non-financial liabilities stood at 264.8 percent of GDP (Caixin, November 3, 2021). By the end of 2021, external debt had reached $2.75 trillion (Xinhua, March 25). The debt of companies owned by local governments is predicted to reach 51 percent of GDP this year, with the total expected to rise 14 percent by the end of next year (Nikkei Asia, June 3). As part of its plan to stimulate the economy, Beijing will incur an additional $13.4 trillion in loans over 2022. However, this stimulus may only forestall, rather than prevent a severe contraction.

The debt-ridden real estate sector and related activities account for 29 percent of China’s total GDP (Nikkei Asia, August 13). This year, however, new housing sales are down 27 percent and developers have defaulted on or delayed on 99 payments. Compounding these difficulties, homebuyers in over 300 unfinished projects are now refusing to pay their mortgages, adding to the industry’s cash crunch, affecting $133 billion of outstanding debt. Consequently, 20 percent of developers are facing insolvency. Widespread defaults in the sector could cause a major economic crisis. As real estate accounts for 26 percent of total outstanding loans, the negative impact on the PRC’s GDP growth would be tremendous. It is estimated that a 20 percent decrease in real estate investment could cause the country’s GDP to contract anywhere from five to ten percent. Additionally, roughly 15 percent of urban jobs are dependent on the property sector, meaning that a collapse would have ripple effects across the entire economy (Nikkei Asia, August 13).

Overseas Lending 

Through BRI and other overseas ventures, China Beijing has extended hundreds of billions of dollars in loans to foreign countries, including $153 billion to African public-sector borrowers (Nikkei Asia, November 4).These investments were made with the expectation of receiving interest payments or some other return on investment. However, following two years of COVID-19 lockdowns, major inflation, U.S. interest rate hikes, the impact of Russia’s war with Ukraine and increased energy and food costs, many of these countries are unable to repay their loans.

Most recently, China has agreed to write off interest-free loans for 17 African nations (SCMP, August 24). Current estimates posit that over half of the countries holding overseas loans are in economic distress. Meanwhile, other countries are seeking loan restructuring or forgiveness. Every write-off or write-down represents an asset leaving the books of a PRC entity, exacerbating an economy already on the brink of an economic crisis due to its increasing debt-to-asset ratio.

Local Government Debt, LGFVs and Off-Balance Sheet Debt 

By the end of 2020, local governments were responsible for about $4.03 trillion in outstanding debt (Xinhua, December 17, 2021). Between this January and August, Beijing issued another $850.2 billion in loans to local governments (Global Times, October 8). These administrations would normally repay their debt with land sales, but revenues from real estate are down 31 percent this year (Nikkei Asia, August 13). Due to a slowing economy and dampening land sales, a shortfall of $900 billion is expected (Nikkei Asia, July 17). Some 30 percent of local governments could face a financial crisis by the end of the year (Nikkei Asia, August 13).

On top of explicit balance sheet debt, the central government may have to cover direct debt issued by local administrations. This includes local government financing vehicles (LGFV), government-backed spending and construction funds issued by state-owned policy banks, such as the China Development Bank, the Export-Import Bank of China and the Agricultural Development Bank of China.

Beijing used stimulus spending, as well as loose monetary policy, to guide the country through the 2008 global financial crisis (Xinhua, January 10, 2010). Despite increased spending, the central government’s budget deficit in 2009 only increase slightly (National People’s Congress, March 19, 2010). This suggests that these projects were largely financed through off-budget spending by local governments. As such, debt from the stimulus would not appear on the central government’s balance sheet.

Augmented fiscal debt, which is calculated by adding any unaccounted-for losses the central bank incurs or government loans issued to recapitalize financial institutions to the overall balance, is a much-overlooked indicator of a country’s economic health. This includes off-budget spending by local governments, which Beijing used to combat the effects of the COVID-19 lockdowns, much of which was funded by LGFVs.

Unlike other state-owned enterprises, LGFVs are established and owned by local governments (Nikkei Asia, September 19). However, if these entities slide into default, the central government may need to step in to bail them out. This greatly increases the PRC’s potential liabilities. This year, LGFVs are struggling to make their payments, with 43 paying late or defaulting as of the end of August (Caixin, September 16; Nikkei Asia, September 19). All told, LGVFs represent $7 trillion dollars of in liabilities at the end of 2020 (SCMP, November 2, 2021).

Loss of Confidence

Foreign investors are cooling on China. For seven straight months, foreign investment has been flowing out of the country. This August alone, $83 billion left the foreign bond market (Nikkei Asia, October 7). Due to their concern for the future, many families in China are holding onto their cash. Bank deposits increased by $2.8 trillion in the first half of 2022. Household deposits alone rose by a record $1.42 trillion. Consequently, consumer spending is down, with overall consumption contracting by 1.5 percent compared to a year earlier. This makes economic recovery problematic as consumption accounts for 40 to 50 percent of the nation’s economic growth (China Daily, July 14).

No Clear Fix

In the past, the government has used infrastructure spending funded through LGFVs to buy its way out of economic downturns. However, with existing LGFVs in peril, it is unlikely that issuing new ones will save the PRC’s economy. Additionally, as defaults and near-defaults are reported, investor confidence is likely to decline even further. This will result in demand for higher yields and drive up the cost of borrowing for Beijing.

As the yuan recently hit a low not seen in decades, breaking seven to the dollar, the central bank is planning to use dollars to buy up yuan and drive the price back up. As a result, the PRC’s foreign currency reserves declined by $26 billion in September (Trading Economics). As foreign debt has to be serviced in dollars, depleting its reserves to buy the yuan may not be the best strategy for the central bank. This is particularly true while the central bank continues to maintain low interest rates, because this suppresses the value of the yuan (Xinhua, August 16).

It appears that Beijing will try to use infrastructure spending to rescue the economy again. However, the GDP boost from these infusions has declined in recent years. In the past, when China built roads and railways linking neglected parts of the country, the resulting contributions to GDP far outweighed the cost.

For China, urbanization—shifting hundreds of millions of people from rural farms to urban enterprises —has significantly increased the average GDP contribution from each worker. Now, with roads and railways connecting most of the country, and with roughly 65 percent of the population already urbanized, money spent on improved infrastructure is only marginally effective in comparison to other ways to stimulate the economy (Xinhua, February 22).

Increased government spending will still increase the money supply and create employment, but this is a short-term fix instead of a solution that yields increased future revenue streams. Additionally, further spending will add to China’s already massive debt load. Other long-term systemic issues pressuring the economy are an aging population and a shrinking workforce. Beijing has no solutions for these problems either, so it seems the days of breakneck growth are over. Thus, China’s ambition to surpass the U.S. as the world’s largest economy may be several decades away, if that day ever comes.

Antonio Graceffo, PhD, China-MBA is an American economist and university professor who works as a China economic analyst. He spent 20 years in Asia, including 7 in China and 3 in Mongolia, publishing over 10 books, including three about the Chinese economy. He has also published numerous articles and papers on the Chinese economy, as well as the Mongolian economy.