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70 Deleveraging, What Deleveraging
As a consequence, China is facing a poisonous combination of high, fastgrowing
leverage and slowing nominal GDP (Figure 4.27). This, in turn, suggests
growing difficulties in servicing and repaying debt in a number of sectors in the
future are likely. These difficulties might be exacerbated by the fact that market
rates are likely to increase as a consequence of ongoing financial reforms.
Figure 4.27 Chinese leverage and underlying nominal GDP growth
17.0
16.0
China: Nominal growth (HP filter)
China: Total debt/GDP (rhs)
220
210
15.0
200
14.0
190
13.0
180
12.0
170
11.0
160
10.0
150
9.0
05 06 07 08 09 10 11 12 13
Source: Authors’ calculations based on national account data.
140
In addition to these patterns, the debt situation in China is made even more
fragile by two further considerations. First, the recent increase in debt was raised
especially by relatively weak borrowers, such as local governments with fragile
income streams and, in particular, companies active in construction and other
sectors (e.g. the steel producing industry) plagued by overcapacity (the driver
of private debt in Figure 4.26). Second, credit was granted by relatively weak
lenders, as shown by the sharp increase of the weight of shadow banking (trust
funds, etc.) within total lending (Figure 4.28).
These factors help to explain the Chinese effort for structural reforms aiming
at supporting potential growth and breaking the formation of a vicious spiral
between leverage and growth. The success of this effort will be crucial to the
future of China. However, it is legitimate to be sceptical about the potential
of reforms to boost short-term growth, even reforms that are successful in the
medium term.
In China, as elsewhere, it is hard to identify in advance the leverage breaking
point beyond which a crisis enfolds. It is less hard, however, to interpret the current
debt dynamics of debt as unsustainable. Most likely, the Chinese government is
aware of the adverse dynamics that we have described and is willing to start a
process of deleveraging. At least initially, this process should be in the form of a
moderation in the pace of the leveraging up of the economy. However, there will