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 largely off-the-books financial subsidiaries, and real estate.
One of the main issues for Treasury Secretary Janet L. Yellen during her visit to Beijing this week is whether she can persuade China to cooperate more in dealing with a developing debt crisis facing low-income countries. But China’s state-controlled banking system is wary of accepting losses on foreign loans when it faces much larger losses on loans inside China.
How much debt does China have?
It’s hard to know exactly because official data is scarce. Researchers at JPMorgan Chase calculated last month that overall debt in China — including households, companies and the government — reached 282 percent of the country’s annual economic output. That compares with 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 accumulated relative to the size of its economy. By comparison, in the United States or even deeply indebted Japan, the debt increased less quickly. The steep rise in China’s debt, more than doubling the size of its economy since the global financial crisis 15 years ago, is making it difficult to manage.
China’s lending to developing countries is small relative to its domestic debt, representing less than 6 percent of China’s annual economic output. But these loans are particularly politically sensitive. Despite heavy censorship, periodic complaints appear on Chinese social media that banks should lend the money to poor households and regions at home, 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 suffering from overbuilding, falling prices and beleaguered potential buyers. In the past two years, several dozen real estate companies that borrowed money from foreign investors have defaulted on those debts, including two more in recent days. Developers have struggled to continue paying much larger debts to banks inside China.
Adding to the problem local governments borrowed. Over the past decade, many cities and provinces have set up special financial units that have been lightly regulated and heavily lent. Officials used the money to cover daily expenses, including the interest on other loans, as well as the construction of roads, bridges, public parks and other infrastructure.
The real estate and government debt problems overlap. For many years, the main source of income for localities came from the sale to developers of long-term leases for state land. As many private sector developers ran out of money to bid for land, this income fell. The local financial subsidiaries instead did the heavy borrowing to buy the land that such developers could no longer afford, at steep prices. As the real estate market continues to weaken, many of these financial affiliates are in trouble.
That debt piled up. Fitch Ratings, the credit rating agency, estimates that local governments have debts equal to about 30 percent of China’s annual economic output. Their subsidiary financial units owe debt equal to another 40 to 50 percent of national output — although there may be some double counting when local governments borrow and then transfer the debt to their financial units, Fitch said.
Why is this important?
For any government or business, borrowing can make good economic sense if the money is used productively and efficiently. But borrowers who default on debt that doesn’t generate sufficient returns can get into trouble and struggle to repay their lenders. That is what happened in China. As its economy slows, a growing number of local governments and their financial units are unable to continue paying interest on their debts. The ripple effect means that many places lack 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 inferior countries. However, many of these countries, such as Sri Lanka, Pakistan and Suriname, are now facing considerable economic difficulties.
Almost two-thirds of the world’s developing economies depend on commodity exports. The World Bank forecast 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, Va.
China is by far the largest sovereign lender to developing countries, although Western hedge funds have also bought many bonds from those countries. The bonds tend to be at fixed interest rates. But China’s banks have tended to lend dollars at adjustable interest rates that are linked to rates in the West. As the Federal Reserve raised rates sharply starting in March 2022, developing countries faced rising 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 repayment, money that could otherwise be 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 is the solution?
China’s internal debt overflows quick fixes. The country must gradually move away from debt-ridden government construction projects and heavy national security spending, to 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 can do little to influence them.
Last winter, 21 Chinese banks agreed to let a local government finance unit in southwest China extend the repayment of loans close to maturity by up to 20 years, and said that only interest payments, not principal, needed to be repaid for the first 10 years. But that arrangement meant heavy losses for the banks – and almost every province in China similarly troubled local financial units.
However, solving the developing country debt problem will be difficult. “Yellen’s ability to urge China to accept debt is limited,” said Mark Sobel, a former longtime US Treasury official. “The US and Yellen have little leverage,” he added.