Google “China’s credit crisis” and you will see it is no secret how anxious the world is about the debt situation of the once juggernaut of global economic growth. The truth is China is doing something – in fact a lot – but tackling the credit problem is not on the top of its to-do list. The International Monetary Fund has been keeping an eye on the matter; urging the world’s second largest economy to take action before it spirals out of control.

It started with the best of intentions from the Chinese government to stimulate the economy in the wake of the global financial crisis in 2008. However, as debt grew exponentially in the last decade, the growth in credit is not delivering the same kind of economic boost it once did. While the rate at which China is taking on debt is a concern, what is keeping investors on their toes is the type of loans the country is generating.

According to the Bank for International Settlements, China’s overall debt stands at approximately 250 per cent of GDP, but more than two-thirds stem from corporate and household debt. This issue is challenging to tackle since credit growth moves in the same direction as economic growth. When the cost of borrowing goes up, spending and economic growth may weaken.

If China were to continue the current rate of its credit growth, it will most certainly hit 400 per cent of GDP in less than five years. Compare this to the US, where its share of debt has hovered around half of China’s at 250 per cent of GDP over the last decade. Meanwhile, Japan’s total debt level stands at 400 per cent of GDP, but only a quarter of this is attributed to private debt.

In China, the construction industry contributes approximately 15 per cent of GDP compared to 5 per cent in Japan, and 4 per cent in the US. Since the real estate market is built primarily upon debt; developers borrow to build, and buyers borrow to buy, meaning that a slowing credit cycle will amplify risk.

What this means for investors

Amid concerns, optimists, however, see a silver lining. Our data indicates that while Chinese developers are still borrowing, the rate has significantly slowed since 2009, and particularly so during the period of increased government regulations in 2014. Chinese property developers continue to be profitable and we have yet to see any non-performing loans within this sector. This shows the effectiveness of China’s efforts to rebalance credit growth towards more sustainable drivers.

Economists are likening China’s current credit cycle situation to how Japan’s bubble burst in the 1980s, when asset prices were greatly inflated. But the situation is likely to remain stable, given that more than 90 per cent of debt is held domestically, and we believe the Chinese government will have buffers and short-term plans in place, such as debt-to-equity programmes, to mitigate China’s current credit challenges with the market unlikely to bottom out further.

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