China Central Bank Admits It Has A Debt Problem, Warns No Easy Solution

It's a well-known risk, perhaps the biggest to the global financial system: China's debt is too high, with estimates ranging from 250% to 300% of GDP per the IIF:

And while China has largely ignored, or avoided, discussing the troubling implications of its unprecedented debt load, this changed today when the head of China's central bank, Zhou Xiachuan finally admitted that it has a debt "problem" saying that corporate debt levels are too high and that "it will take time to bring them down to more manageable levels", underlining what has become the defining battle to put the world's second-largest economy on a more sustainable footing: keeping GDP growing at 6.5% (or above) while injecting trillions in new debt.

"Non-financial corporate leverage is too high," PBOC Governor Zhou Xiaochuan told reporters at a news conference on the sidelines of the annual parliament session.

Quoted by Reuters, he said that efforts will be made to contain debt levels, including restructuring of firms with heavy debt burdens, alongside a push to reduce excess industrial capacity.  Furthermore, banks will withdraw support for financially unviable firms, he added, repeating pledges by other officials last year to drive such "zombie" firms out of the market.

"I personally think this process is relatively medium-term. It won't have very obvious results in the short-term because the existing stock (of debt) is very large," he said.


Zhou Xiaochuan, Governor of the People's Bank of China, attends a news

conference in Beijing China March 10, 2017. REUTERS/Jason Lee

Zhou also said that measures by local governments to cool rising house prices will slow mortgage growth to some degree, but housing loans will continue to grow at a relatively rapid pace. We profiled China's mortgage debt problem last October when we showed that over 70% of all new loans went to fund mortgages, which in turn now account for a fifth of total Chinese outstanding loans.

According to official data, China's debt-to-GDP has risen to 277%, up nearly 25% since the end of 2016 when it was 254%, with an increasing share of new credit being used to pay debt servicing costs, UBS analysts said in a note. In other words, China now finds itself in the "ponzi financing" stage of its debt lifecycle, with a "Minsky Moment" approaching fast. 

China's credit growth has been "very fast" by global standards, and without a comprehensive strategy to tackle the overhang, there is a growing risk it will have a banking crisis or sharply slower growth or both, the IMF warned late last year.

While China's leaders have pledged to contain debt and housing risks in 2017 after years of credit-fueled expansion, which has been propelled by the need to meet official economic growth targets, this has proven to be problematic with expectations that China will have to issue over $3 trillion in debt in the coming year, and as a result most analysts remain doubtful over the government's commitment to follow through on potentially painful reforms, especially if growth falters.

Despite his dour admission, according to Reuters Zhou, who took control of the PBOC in 2002 and is the under the radar architect of China's financial reforms, was seeimingly in a very good mood, smiling and engaging with the deputy governors beside him as well as news journalists throughout  the news conference. 

China's corporate debt has soared to 169 percent of gross domestic product (GDP), according to figures from the Bank for International Settlements. China needs to first stabilize its overall debt levels before gradually reducing them, deputy central bank governor Yi Gang said at the same briefing.

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Perhaps more troubling to China's liquidity addicts, Zhou said that the central bank's tilting towards a neutral stance would help with China's supply-side reforms, reiterating that it would be "prudent" while reminding markets that the central bank has many policy tools at its disposal. In recent months, the PBOC has cautiously moved to a modest tightening bias in a bid to cool explosive growth in debt and discourage speculative activity, though it is treading cautiously to avoid hurting economic growth. It surprised financial markets by raising short-term interest rates in January and February by marginal amounts, and is expected to bump them higher in coming months, though an increase in its benchmark policy lending rate is seen as unlikely this year.

Over the weekend, Beijing set a more modest economic growth target of "around 6.5%" this year, easing from last year's 6.5-7 percent range, ostensibly to give policymakers more room to focus on financial risks. The economy ultimately expanded 6.7 percent last year, but much of the growth came from record lending by state banks and higher government spending on infrastructure, which has helped revived the long ailing and heavily indebted industrial sector.

Still, despite promises of deleveraging, Beijing's trajectory remains much of the same: bank lending in January was the highest on record and it did not slow as much as expected in February.

"If there is too much money in the economy, in fact it is very harmful to the economy as it might lead to problems such as higher inflation and asset price bubbles," Zhou said.

While admission of the problem is a key first step, few have any faith that China will take the necessary, and very painful, next steps to remove the debt froth that has kept not only China, but the global growth dynamo turning, especially now that the global credit impulse, as UBS demonstrated two weeks ago, has tumbled and is on the verge of turning negative.

Our global credit impulse (covering 77% of global GDP) has suddenly collapsed: as the chart below shows the 'global' credit impulse over the last 18 months is essentially mainly China (the green shaded bit), which even now is still creating new credit at an annualized rate of around 30pp of (Chinese) GDP. But the credit impulse is the 'change in the change' in credit and even the Chinese banks could not sustain the recent extraordinary pace of credit acceleration. As a result: whereas back in Jan '16 the global credit impulse was positive to the tune of 3.8% of global GDP (of which China comprised 3.5% of global GDP) it has now fallen back to -0.1% of global GDP (China's contribution is -0.3% of global GDP).

Should the impulse turn negative outright, the transition would have dire implications for the global growth, and reflation, cycle.