Personal Finance
Business

January 31, 2019

China's Complicated Web of Debt

After returning from the World Economic Forum in Davos, Dave McKay, CEO of RBC, penned some thoughts on 11 key points of discussion at the gathering.

One of the major issues he mentioned is the broad issue of China challenging the existing world order. While that is the clear intention, there are a lot of potential obstacles, not the least of which is their huge pile of credit in all parts of the economy.

This issue has a lot of colorful descriptions — “a credit crisis with Chinese characteristics" or “a debt iceberg with Titanic credit risks." The fact is, Chinese borrowing grew from 162 percent of GDP in 2008 to 266 percent in 2017. With China as a major driver of global growth, this is worrying in many ways.

Part of what got China into this situation is the diverse and fast-moving nature of its developing financial infrastructure, which has involved credit vehicles with little regulation by the Chinese government.

They are particularly focused on local government funding vehicles, which can get very convoluted and contribute to a large shadow banking sector. Last fall, S&P Global Ratings estimated that “hidden" local government debt in China could total $5.8 trillion— roughly double what China reports as government debt on its balance sheet.

The good news, if you can call it that, is that no one recognizes the reality of the situation more than the Chinese government, which is actively trying to manage the situation. But as anyone who has had a great deal of personal or corporate debt knows, managing a draw down of substantial debt can be difficult.

That difficulty multiplies when you are in a situation like China faces. Just as China started to crack down on credit, the stress of trade tensions actually put pressure on its government to do the opposite — ease credit conditions to minimize the hit to the economy from tariffs.

My View: The pressing question in markets is whether or not China can manage down its debt load without sparking a credit crisis that spreads around the world. I don't doubt the skill and professionalism of the Chinese government, yet even the best-case scenario means years of slogging through the debt mountain. Worst case, of course, is a spark that spreads around the world — but I don't see that on the horizon just yet.

Thank you for subscribing!
Error. This is not a valid email address. Please try again.
Error. Please make sure all fields are properly filled out and try again.
Subscribe to Our Newsletter

The information in this report was compiled by the staff at City National Bank from data and sources believed to be reliable but City National Bank makes no representation as to the accuracy or completeness of the information. The opinions expressed, together with any estimate or projection given, constitute the judgment of the author as of the date of the report. City National Bank has no obligation to update, modify or amend this report or to otherwise notify a reader in the event any information stated, opinion expressed, matter discussed, estimate or projection changes or is determined to be inaccurate. This report is intended to be a source of general information. It is not to be construed as an offer, or solicitation of an offer, to buy or sell any financial instrument. It should not be relied upon as specific investment advice directed to the reader's specific investment objectives. Any financial instrument discussed in this report may not be suitable for the reader. Each reader must make his or her own investment decision, using an independent advisor if prudent, based on his or her own investment objective and financial situation. Prices and availability of financial instruments are subject to change without notice. Financial instruments denominated in a foreign currency are subject to exchange rate risk in addition to the risk of the investment. City National Bank (and its clients or associated persons) may, at times, engage in transactions in a manner inconsistent with this report and, with respect to particular securities and financial instruments discussed, may buy from or sell to clients or others on a principal basis. Past performance is not necessarily an indication of future results. This report may not be reproduced, distributed or further published by any person without the written consent of City National Bank. Please cite source when quoting.