China, which has lent nearly $1 trillion to about 150 developing countries, has been reluctant to write off large debts from countries struggling to make ends meet. That is at least in part because China faces a debt bomb at home: trillions of dollars owed by local governments, their informal 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 cooperate more to address the evolving debt crisis facing low-income countries. But China’s state-controlled banking system is wary of accepting losses on foreign loans when faced with much larger loan losses inside China.
How much is China’s debt?
It’s hard to know exactly because official data is scarce. Researchers at JPMorgan Chase calculated last month that total debt within China – including households, businesses and government – has reached 282% of the country’s annual economic output. This compares to an average of 256% in advanced economies around the world and 257% in the United States.
What sets China apart from most other countries is how quickly debt builds up relative to the size of its economy. By comparison, in the indebted United States or even Japan, debt has risen less steeply. The sharp increase in China’s debt, which has more than doubled the size of its economy since the global financial crisis 15 years ago, is making it more difficult to manage.
China’s lending to developing countries is minimal relative to its domestic debt, accounting for less than 6% of annual Chinese economic output. But these loans are particularly sensitive politically. Despite heavy censorship, complaints periodically appear on Chinese social media that banks should have lent money to poor households and regions at home, rather than abroad. Accepting huge losses on these loans would not be very popular within China.
How did China enter a deep debt hole?
It started with properties suffering from overbuilding, falling prices and besieging potential buyers. In the past two years, dozens of real estate developers who borrowed money from foreign investors have defaulted on those debts, including two more in recent days. Developers struggled to continue paying much larger debts to banks inside China.
Compounding the problem is borrowing by local governments. Over the past decade, many cities and provinces have set up private financing units that were poorly organized and borrowed heavily. Officials used the money for day-to-day expenses, including interest on other loans, as well as building roads, bridges, parks, and other infrastructure.
Real estate problems and government debt overlap. For many years, the main source of revenue for the localities came from the sale of long-term leases of state land to developers. With many private developers running out of money to bid for land, that revenue has plummeted. Instead, their local finance companies took on heavy borrowing to buy the land these developers could no longer afford at exorbitant prices. As the real estate market continues to be weak, many of these affiliate finance companies are on the hook.
These debts have accumulated. Credit ratings agency Fitch estimates that local governments have debt equivalent to about 30 percent of China’s annual economic output. Fitch said its financing units owe an additional debt equal to 40 to 50 per cent of GDP – although there may be some double counting as local governments borrow and then transfer the debt to their financing units.
Why is this important?
For any government or company, borrowing can make good economic sense if the money is used productively and efficiently. But borrowers who are over-indebted that do not generate sufficient returns can run into problems and struggle to repay their lenders. This is what happened in China. As its economy slows, more and more local governments and their financing units are unable to continue paying interest on their debts. The multiplier effect means that many localities lack the funds 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. However, many of these countries, such as Sri Lanka, Pakistan and Suriname, are now facing great economic difficulties.
Nearly two-thirds of the world’s developing economies depend on commodity exports. In April, the World Bank predicted that commodity prices would drop by 21 percent this year compared to last year.
In 2010, only 5% of China’s overseas lending portfolio supported cash-strapped borrowers. Today, that number is at 60 percent, said Bradley Parks, executive director of AidData at William & Mary, a university in Williamsburg, Virginia.
China is by far the largest sovereign lender to developing countries, although Western hedge funds have also bought many bonds from these countries. Bonds tend to have fixed interest rates. But Chinese banks tend to lend dollars at adjustable interest rates linked to rates in the West. With the Fed sharply raising interest rates since March 2022, developing countries have faced mounting debt payments to China.
If not much is done to reduce their debt, many of the world’s poorest governments will continue to spend heavily on debt repayments, money that could have been used for schools, clinics and other services. “The biggest losers will end up being ordinary people in the developing world who are denied basic public services because their governments are saddled with unsustainable debt,” Mr. Parks said.
What’s the solution?
China’s domestic debt burden defies quick fixes. The country needs to gradually move away from debt-fueled government construction projects and massive spending on national security, toward an economy that relies more on consumer spending and services.
Powerful constituencies in Beijing and Chinese provincial capitals protect current economic priorities. Ms. Yelin will try to find out more about China’s economic plans, but she can do little to influence them.
Last winter, 21 Chinese banks agreed to allow a local government finance unit in southwest China to extend the repayment of loans that were about to be repaid into 20 years, and said only interest payments, not principal, were to be made for the first 10 years. years. But the arrangement meant huge losses for the banks – and nearly every province in China upset local finance units.
However, solving the debt problem of developing countries will be difficult. “Yelin’s ability to get China to accept debt reduction is limited,” said Mark Sobel, a former longtime US Treasury official. “The United States has little leverage,” he added.