Everyone has got China's debt problem all wrong
- Analysts tend to focus on the default risk of China's huge debt burden.
- Default risk can be overcome by the Chinese government socializing the debt burden.
- The real risk lies in the unproductive use of debt which will affect China's productivity.
NEW YORK - The consensus on Wall Street is that debt is the most pressing problem facing the Chinese economy. The long-term risks of piling on debt have also been well-documented before.
The consensus view may be wrong, however, according to Macquarie's most recent global macro outlook report authored by Peter Eadon-Clarke's team.
"It's popular to argue that China will run into a debt crisis in either local government debt or corporate debt," the team noted. "By contrast, our long-held view is that China's debt problem is very different from many other countries."
That's because, the team argues, China's corporate debt could be socialized by the government.
"Policy-makers could reshuffle debt among different entities: central government, local government, SOEs and banks," they noted. "The discussion on debt/equity swap suggests that it's possible to transfer the SOE debt burden to governments and banks. By doing so, the government also lowers the odds for a corporate debt crisis."
That isn't to say that debt doesn't pose a problem for China. It's just that it isn't the usual problem.
"In our view, the real risk behind China's debt is capital misallocation, as the majority of credit is poured to the less-efficient SOEs and local governments rather than the private sector," the analysts noted.
Instead, the deleterious effects of the debt will likely be felt in the long run in the form of slower growth.
In the words of Macquarie's Research team, "capital misallocation could undermine China's potential growth in the long run, causing the country to become stuck in the so-called 'middle-income trap'" as unproductive debt does not lead to sustainable economic growth by improving productivity.
"During the Asian Financial Crisis," the team noted, "the average step-down in gross capital formation to GDP, 1996-98, for Malaysia, Thailand, Indonesia and Korea was approximately 14%."
The catalyst of the precipitous decline was "a hard-stop by capital providers, cross-border bank lending." If something similar were to transpire in China today, they noted, the equivalent "would be a hard-stop of capital provision by the household sector, i.e. bank deposits leaving the Chinese banking system en masse."