Gene Frieda in Project Syndicate:
China’s debt/GDP ratio, reaching 250% this month, remains significantly lower than that of most developed economies. The problem is that China’s stock of private credit would normally be associated with a per capita GDP of around $25,000 – almost four times the country’s current level.
There are strong parallels between China’s current predicament and the investment boom that Japan experienced in the 1980s. Like China today, Japan had a high personal savings rate, which enabled investors to rely heavily on traditional, domestically financed bank loans. Moreover, deep financial linkages among sectors amplified the potential fallout of financial risk. And Japan’s external position was strong, just as China’s is now.
Another similarity is the accumulation of debt within the corporate sector. Corporate leverage in China rose from 2.4 times equity in 2007 to 3.5 times last year – well above American and European levels. Nearly half of this debt matures within one year, even though much of it is being used to finance multi-year infrastructure projects.
Making matters worse, much of the new credit has originated in the shadow-banking sector at high interest rates, causing borrowers’ repayment capacity to become overstretched. One in five listed corporations carries gross leverage of more than eight times equity and earns less than two times interest coverage, weakening considerably these companies’ resilience to growth shocks.