China has a longstanding tradition in creating huge debts, and the burden has been growing over the past year, as the government decided to bail out failing companies, rather than let them collapse. That system has to change, writes financial analyst Sara Hsu in the Diplomat.
For the past year, analysts have noted that China’s debt has been steadily mounting. Currently, the debt to GDP ratio sits at about 250 percent. Much of the growth in debt originated from climbing local government debt, undertaken in order to build up infrastructure, as well as from increasing corporate debt, stemming in large part from the real estate sector. What are some potential resolutions to China’s debt woes?
Local governments appear to have some resolution in sight, as they can now roll over their debt into municipal bonds. Although this does not address structural issues that would rule out the incursion of new debt going forward, it does provide significant relief to local governments that participate in the program. Many local governments, via their associated financing vehicles, have taken on new debt just to repay existing debts, and are therefore in dire need of a legitimate way in which to roll over their existing loans…
At this point, it seems inevitable that some smaller property developers will collapse, but it is also likely that some developers will receive a bailout. Those who obtained trust loans and cannot repay them, for example, may find their funds paid by the local government or another entity, if history is any guide. Other developers may turn to the informal financial market of family, friends, and private money lenders to roll over their debt.
Unfortunately, these resolutions to China’s debt woes are second-best. A better alternative would be to improve the bankruptcy process and allow companies to declare bankruptcy so that debt and assets can be dealt with efficiently. Even in the case of collapsed firm Zhejiang Xingrun Real Estate Co, local officials skirted the stigma of bankruptcy by dealing with winding down debt and assets themselves, rather than going through a more streamlined bankruptcy process. In cases where firms only face liquidity, rather than solvency, issues, the provision of short-term emergency loans (not bailouts) to less risky firms with conditionality may prevent liquidity issues from becoming more serious.
Although China’s debt debacle has not yet caused a financial crisis, its coping mechanisms are less than ideal. Future reforms should remove government accountability for financial and non-financial firm failures and enhance the options facing troubled firms. These reforms are not a given, and are important changes to make as China’s economy becomes more market-oriented.
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Earlier this week, Sara Hsu joined the China Hangout and discussed the current state of the country´s financial situation.