China’s “Vast Pit Of Debt”

China, Company Strategy, Economics

By John Richardson

ChinaconstructionTHE consensus has further shifted in our direction, as this editorial in yesterday’s Financial Times indicates.

This mainstream newspaper pulled no punches when it talked about the struggle that China would face in emerging from a “vast pit of debt”.

Back in February, the BBC also backed many of the arguments that we have been putting forward for the past three years.

It was only ever  a question of when rather than whether – and, as we warned late last year – 2014 looked almost certain to be the when.

The FT, in yesterday’s article, underlined the extent of the rebalancing challenges when it pointed out that:

  • Total Chinese debt has virtually doubled since the financial crisis to around 240% of GDP, according to Fitch, the credit rating agency.
  • This means that debt service charges, assuming an average interest rate of 7%, are set to reach about 17% prospective GDP, or $1.7tn.
  • To put this number into perspective, it is likely that Chinese debtors – including its government, agencies, companies and individuals – will end up paying an interest bill that is not far off the size of India’s GDP last year ($1.87tn) and considerably larger than the economies of South Korea ($1.3tn), Mexico ($1.26tn) and Indonesia ($870bn).
  • Chinese companies and individuals are, thus, increasingly preoccupied with repaying loans and correspondingly less inclined to invest or spend. In fact, the interest repayment burden has burgeoned so quickly that it now matches the $1.7tn that private companies invested in factories and equipment in the first nine months.

Investment in the key real estate sector, worth some 20% of the economy is, of course, falling off a cliff as all this debt is unwound.

“Certain provinces have increased real estate investment, by anywhere between 300 and 500% over the past five years, [and] as the real estate downturn deepens, those provinces are getting absolutely hammered – provinces like Guizhou, Qinghai, Hainan,” said Andrew Polk, an economist at the Conference Board China Centre for Economics and Business in Beijing.

“You’ve got high inventory in almost every sector in the economy, and now demand is falling off, and investment is starting to fall off, so companies are now having to sell some of that inventory,” he added.

“When you start selling your inventory, you stop manufacturing new goods, and that’s one of the things that’s driving weak industrial production.”

What do you do with this information? Get depressed? Run away from the problems and pretend that they are, actually not as bad as all the above – and that the new consensus must be wrong?

Of course not. Instead, your chemicals company needs some new scenario planning. This is where we can help.

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