Global Courant
China, which has lent nearly $1 trillion to some 150 developing countries, has been reluctant to cancel large debts owed by countries struggling to make ends meet. That’s at least in part because China faces a debt bomb at home: trillions of dollars owed by local governments, their mostly off-the-books financial affiliates, and real estate developers.
One of the key issues for Treasury Secretary Janet L. Yellen during her visit to Beijing this week is whether she can persuade China to step up cooperation to tackle a advancing debt crisis facing low-income countries. But China’s state-controlled banking system is hesitant to accept losses on foreign loans if it faces much larger losses on loans within China.
How much debt does China have?
It’s hard to know exactly because official data is scarce. JPMorgan Chase researchers calculated last month that total debt in China — including households, businesses and government — had reached 282 percent of the country’s annual economic output. That compares to an average of 256 percent in developed economies around the world and 257 percent in the United States.
What sets China apart from most other countries is how quickly that debt has built up relative to the size of its economy. By comparison, in the United States or even deeply indebted Japan, debt has risen less rapidly. China’s soaring debt, more than doubling compared to the size of its economy since the global financial crisis 15 years ago, is making it more difficult to manage.
China’s loans to developing countries are small relative to domestic debt, representing less than 6 percent of China’s annual economic output. But these loans are politically very sensitive. Despite heavy censorship, periodic complaints surface on Chinese social media that banks should have lent the money to poor households and regions domestically, not abroad. Accepting heavy losses on these loans would be very unpopular in China.
How did China get into such a deep debt hole?
It started with real estate, which suffers from overbuilding, falling prices and beleaguered potential buyers. In the past two years, several dozen real estate developers who borrowed money from foreign investors have defaulted on those debts, including two more in recent days. Developers are struggling to continue paying much larger debts to banks in China.
The problem is compounded by borrowing by local governments. Over the past decade, many cities and counties created special finance units that were lightly regulated and heavily borrowed. Officials used the money to cover day-to-day expenses, including interest on other loans, as well as building roads, bridges, public parks and other infrastructure.
The real estate problem and the sovereign debt problem overlap. For many years, the main source of income for municipalities has been the sale of long-term state land leases to developers. With many private sector developers running out of money to bid for land, these revenues have fallen. The local financing partners instead made the heavy loans to buy the land that such developers could no longer afford, at high prices. As the real estate market continues to weaken, many of these financing partners are in trouble.
That debt has piled up. Fitch Ratings, the credit rating agency, estimates that local governments have debt equivalent to about 30 percent of China’s annual economic output. Their member finance units owe debt equal to another 40 to 50 percent of national output — though there may be double-counting when local governments borrow and then shift the debt to their finance units, Fitch said.
Why is this important?
For any government or business, borrowing can make economic sense if the money is used productively and efficiently. But borrowers who indulge in debt that doesn’t yield enough returns could run into trouble and struggle to repay their lenders. That’s what happened in China. As the economy slows, a growing number of local governments and their financing units are unable to continue paying interest on their debts. The ripple effect means that many places have no money to pay for public services, health care or pensions.
Debt problems have also made it difficult for banks in China to accept losses on their loans to low-income countries. Yet many of these countries, such as Sri Lanka, Pakistan and Suriname, are now facing major economic difficulties.
Nearly two-thirds of the world’s emerging economies depend on commodity exports. The World Bank predicted in April that commodity prices will be 21 percent lower this year than last year.
In 2010, only 5 percent of China’s overseas loan portfolio supported borrowers in financial distress. Today, that figure stands at 60 percent, said Bradley Parks, the executive director of AidData at William & Mary, a university in Williamsburg, Virginia.
China is by far the largest lender of government bonds to developing countries, although Western hedge funds have also bought many bonds from these countries. The bonds usually have a fixed interest rate. But China’s banks tend to lend dollars at adjustable interest rates tied to rates in the West. As the Federal Reserve has driven interest rates sharply since March 2022, developing countries have faced skyrocketing debt payments to China.
If little is done to reduce their debt, many of the world’s poorest governments will continue to spend heavily on debt service, money that could otherwise be used for schools, clinics and other services. “The biggest losers in the end will be the ordinary people of the developing world who are deprived of basic public services because their governments are saddled with unsustainable debt,” Parks said.
What is the solution?
China’s overhanging domestic debt defies quick fixes. The country must gradually move away from debt-fuelled government construction projects and heavy spending on national security, towards an economy based more on consumer spending and services.
Powerful constituencies in Beijing and Chinese provincial capitals protect current economic priorities. Ms. Yellen will try to learn more about China’s economic plans, but has little influence over them.
Last winter, 21 Chinese banks agreed to let a local government finance unit in southwest China extend the repayment of loans that were nearing maturity to 20 years. year. But that arrangement meant heavy losses for the banks – and nearly every province in China has similarly wreaked havoc on local finance units.
Still, it will be difficult to solve the debt problem of developing countries. “Yellen’s ability to push China to accept debt write-offs is limited,” said Mark Sobel, a former Treasury Department official. “The US and Yellen have little influence,” he added.
