Analysis: China Stalls on Debt Reforms
Background
The Chinese government has a $3.5 trillion-dollar problem in the form of local government debt. Most of it accrued in the years between 2007 and 2014, when China’s total debt spiked from $7.4 trillion to $28 trillion, or from 158% of GDP to 282%.
At fault was a massive government fiscal and monetary stimulus program launched in the wake of the global financial crisis. The program succeeded in producing enough infrastructure and real estate projects to weather the economic storm admirably, but it did so at the cost of creating excess supply and a long list of insolvent ventures, many of which were financed by local governments.
Now Beijing is faced with the task of cleaning up this mess, and doing so won’t be easy. Local governments have since been capped on the amount of debt they can take on, and a pilot project for converting local debt to municipal bonds is slowly being implemented, though there are questions concerning the market demand for such bonds.
There will be tradeoffs every step of the way since this is often a question of short-term pain for long-term financial stability. Many observers are starting to draw parallels between China’s current situation and that of Japan’s leading up to its major economic crash in the 1990s. Both suffered from high levels of debt that policymakers were hesitant to write off for fear of a crash; both faced conflicts of interest from state-owned banks; and both bounced their debt problem around by providing easy liquidity in times of tepid growth.
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