A key drag on post-2009 world economic growth has been high debt levels across the globe. The major advanced economies are faced with debt-to-GDP ratios exceeding 350%; in fact, the total debt-to-GDP ratio for advanced economies have stabilised around 385% from 2010 according to the World Bank, with that of Japan exceeding 400%[1]. In the emerging market universe, current debt-to-GDP ratios average much lower around 115% of GDP; however, it is on an upward trajectory, with China in particular growing its national debt at high levels (one source is quoted that China added $3.75 trillion per annum to its national debt over the period since 2011).
Initially China debt-financed strong growth in public sector infrastructure investment in order to counter balance the impact of the Great Recession in 2009/10; however, the debt-financed growth continued in the years thereafter. China’s debt-to-GDP ratio is currently estimated at between 200% and 250%, up from 150% ten years ago. It is speculated that China’s debt-to-GDP ratio may approach that of Japan in three years’ time should the current debt-financed growth model be sustained.
Whilst accelerating debt issuance can boost economic growth over the short term, high debt levels can become a material drag on growth. This result from the accumulation of unrecognised bad debt in the financial system, requiring accelerated debt growth just to roll over bad debts, i.e. beyond the new debt required to finance targeted growth. Periods of debt consolidation invariably lead to lower economic growth. The government has to trim budget deficits and run surpluses to pay back or limit the growth of debt. Corporates have to divert profits into servicing debt rather than fixed investment. Likewise, households tighten their belts and save more/ spend less. Then there are the big negatives that can influence the sentiment of households and businesses alike when debt levels reach crisis proportions. This is the age-old recipe for a financial crisis/ banking meltdown.
The advanced economies have been in a period of debt consolidation since the recovery from the Great Recession. However, the major economies merely succeeded in reducing debt levels in the financial sector, whilst non-financial sector debt continued to grow – in the USA mainly in the public sector and in the Euro area mainly in the non-financial private sector. In emerging economies, debt levels grew rapidly, being led by China as these economies faced low interest rates and countered the recessionary forces from the advanced economies by debt-financed GDP growth. It is therefore speculated that the next financial crisis is likely to originate in the emerging market group of countries. The eyes are pretty much on China with its rapidly rising debt-to-GDP ratio[2].
China has become dependent on debt finance in order to sustain growth around the 6-7% per annum levels. It is calculated that due to the incidence of non-performing loans and the ratcheting up of debt service costs, it currently takes 4 yuan of debt to generate one unit of GDP, compared to debt valued at 1 yuan per unit of GDP generated before the recession (Pettis, 2016: ).
The reality regarding high (and growing) debt levels is that somewhere along the line a country (a business, the government or an individual) needs to assume the pain of deleveraging. The longer this moment is postponed, the bigger the potential crisis and consequent pain later. This is the overwhelming sense regarding the current level of high world debt. World economic growth is underpinned by high (and growing) debt levels and we may just be postponing the inevitable meltdown. The upside scenario is one where the low levels of interest rates spur investment growth and self-sustaining economic growth, which sets governments, corporates and households up for reducing debt levels in a managed way.
In all, high DM debt levels – projected to persist over the next five years – have negative implications for the attainable real economic growth rates in these countries, including scope to stimulate these economies via public sector infrastructure programmes. Furthermore, while EM debt levels are much lower, that of China has leapt ahead over the past couple of years, to levels that make sustained debt-driven growth of 6-7% per annum impossible[3]. Our view is that the Chinese authorities will in time accept this fact and manage growth to lower and sustainable levels.
References:
1. Economist (15 July 2016): China’s Economy: Strong, but for how long?
2. IMF Global Financial Stability Report (GFSR) (April 2016)
3. International Center for Monetary and Banking Studies (ICMB) (2014): Deleveraging? What deleveraging? Geneva Reports on the World Economy 16.
4. Pettis, M (22 June 2016): Rebalancing, wealth transfers, and the growth of Chinese debt, online: http://blog.mpettis.com/2016/06/rebalancing-wealth-transfers-and-the-growth-of-chinese-debt/
[1] Before 2009, the ratcheting up of debt was restricted to the developed market economies (DM). Between 2001 and 2008, the developed economies’ total debt to GDP ratio increased by 60 percentage points to 365% (with more than 20 percentage points originating in the financial sector) (ICMB, 2014: 7-15). After 2009, the DM total debt to GDP ratio increased to (a peak of) 385% and stabilised around that level from 2010 as non-financial sector debt continued to expand, but financial sector debt was reduced.
[2] In emerging market economies (EM), the opposite trends are observable: between 2001 and 2008 the total (non-financial sector) debt ratio remained stable around 115% of GDP; however, increased sharply by 36 percentage points to 151% after 2008. The sharp increase in China’s debt levels accounts for the bulk of the increase in EM debt. China’s national debt shot up from 150% of GDP to around an estimated 280% over the past decade (Pettis, 2016).
[3] Firms’ inability to service debt gives rise to non-performing loans in the banking sector – in 2015 bad loans were estimated at 5.5% of banks’ loan book (or 6% of GDP) and could be as high as 15.5% depending on the methodology used in assessing risk (IMF GFSR, April 2016: 14-16). The Economist has also become more concerned regarding the sustainability of debt-financed high growth in China (Economist, July 2016).
Pieter Laubscher
5 October 2016