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Beijing’s love affair with debt

China loves debt, clearly. While the country’s spiralling debt threatens to upend global markets, Beijings simultaneous debt trap diplomacy burdens developing nations with crippling repayments and provides China with a backdoor into critical civilian infrastructure. In this piece, Defence Connect unpacks the looming Chinese debt threat.

China loves debt, clearly. While the country’s spiralling debt threatens to upend global markets, Beijings simultaneous debt trap diplomacy burdens developing nations with crippling repayments and provides China with a backdoor into critical civilian infrastructure. In this piece, Defence Connect unpacks the looming Chinese debt threat.

Amid a faltering US economy, China’s rise as a global superpower has seemed a natural transfer of power. On the surface, China is an economic powerhouse underpinned by the world's largest population and greatest manufacturing economy. This economic might has enabled the Chinese government to throw around large sums of money, much of it with strings attached, across both the developed and developing worlds to buy influence and exert economic control over governments and foreign companies. None of this is new.

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However, over recent months cracks have started to appear in the Chinese economy. Very large cracks, too.

Dr Antiono Graceffo, author of Beyond the Belt and Road, published an analysis in War on the Rocks this week examining the growing threat of bad debts in the Chinese economy, and how poor lending practices threaten to upend the country's leading financial institutions.

“Between public and corporate debt, China is one of the most indebted large economies in the world. Even worse, its state-owned banks are sitting on mountains of bad debts and non-performing loans, particularly in the real-estate sector,” Graceffo wrote.

“And this is just on the surface. Underneath lies a staggering quantity of murky debt, off-balance-sheet lending, wealth management products, and local government funding vehicles. All told, China’s debt is considerably larger than it appears at first glance, and so high that some analysts feel it is at dangerous levels and could spill over, doing severe damage to the world economy.”

Graceffo argues that a Chinese collapse will impact the entire globe, including many developing nations where China sources its natural resources. Already, Chinese coal and steel imports have begun falling, and in turn, Chinese manufacturing outputs have also begun falling.

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However, some do stand to benefit economically from a faltering Chinese economy in the long term. The analyst argues that on balance of probabilities it is likely that international companies would seek to review their supply chains and relocate to countries such as India, Indonesia and Vietnam.

“Companies in China are suffering from supply chain disruption, higher input costs, pollution curbs, and logistical issues due to pandemic measures, such as fuel rationing, electricity rationing, and disruption at ports. Factory-gate prices, the price of products at the factory, have been steadily rising. All of these circumstances have driven factory inflation to its highest level in 13 years,” Graceffo wrote.

Worryingly, a faltering Chinese economy could spell disaster for Australia and the US. Not only does the US have key investments in China, but China is a critical export-import hub with Western nations. 

“US pension funds, individuals, and institutional investors will suffer as they are invested in the $2.1 trillion dollars of Chinese companies listed on American exchanges. Holders of China’s foreign currency debt would also be at risk to the tune of $2.4 trillion,” Graceffo wrote.

Simply, the Chinese economy is full of bad debt. While global media has remained firmly fixated on the recent Evergrande scenario, Graceffo lists several large Chinese companies which over recent months have begun falling victim to poor lending and financial practices.

“In October another Chinese developer, Fantasia Holdings Group, missed its repayment of $206 million in five-year dollar bonds. Later the same month, China Properties Group’s subsidiary Cheergain Group defaulted on $226 million worth of debt payments,” Graceffo wrote.

“Almost at the same time, another developer, Modern Land China, missed its payment of principal or interest on a $250 million bond. The most recent addition to the default club is homebuilder Sinic Holdings, which also defaulted on $250 million. Yet another Chinese developer, Kaisa Group Holdings, is in danger of missing its debt payments. The company was valued at about $1 billion, but saw its share price drop by 15 per cent when the possible default was announced.”

Despite these figures, there is no real way of knowing the totality of bad debts in China or just how many large Chinese companies are at risk of economic collapse. Indeed, recent findings from economists at Goldman Sachs illustrated that bad lending and liabilities aren't solely a private problem, by demonstrated that debt held by local governments in China amount to half of the Chinese economy. 

How can the Chinese government fix the debt issue?

Analysts have warned that attempts by the Chinese government to mitigate the risk of bad loans by creating additional oversight on lending may in fact hasten the collapse of many Chinese companies who will simply run out of money. Meanwhile, tightening the lending practices for local government entities, which have an estimated US$2.3 trillion of deb, could cause many of the country’s infrastructure projects to grind to a halt.

Compared with the US, China has a very liberal attitude toward classification of debt. Graceffo illustrates that distressed loans are typically not counted as non-performing loans on the balance sheet, with Chinese financial institutions requiring a higher threshold for the loan to be considered bad.

Astoundingly, it appears as though China has taken a leaf out of the US’ pre-GFC book: packaging and selling bad loans.

“To get non-performing loans off a bank’s balance sheets, they are often bundled and sold to investors... For investors, the price of these bundles of non-performing loans is dependent on the statistical probability that the loans will be repaid. By obscuring the repayment risk, the bundle can be sold at a higher price,” Graceffo wrote.

It seems that in response to the faltering economy, Beijing has begun to tighten its purse strings. Just this week, it was revealed that the Chinese government has slashed its foreign investment to Africa to $40 billion. The debt crisis in China has now impacted the Chinese policy of debt trap diplomacy.

Has China’s debt-trap diplomacy worked?

China's domestic markets are poor, which will likely have a flow on to their Belt and Road Partners. Chinese local governments, citizens and companies have straddled themselves with a higher debt-GDP ratio than the US (currently estimated to be 250 per cent). Meanwhile, Reuters has illustrated that China leads the world’s super powers on private debt (210 per cent of GDP versus the US at 151 per cent).

Nevertheless, the Belt and Road Initiative of debt trap diplomacy has been a success for China, enabling the country to exert competitive control over their BRI partners. Here are some headlines from the last few days:

“China’s debt trap strategy: Uganda set to lose its only international airport to Beijing” – WION

“Pakistan struggling to pay its debts to China” – Asia Times

“Debt-trapped: Sri Lanka, Laos, and now Uganda?” – Radio Free Asia

Not only are these developing countries beholden to Chinese economic interests, but China has also used their collaboration with developing countries as a backdoor into their critical infrastructure.

Speaking to BBC Radio 4, MI6 chief Richard Moore warned against China’s debt trap diplomacy. "Trying to use influence through its economic policies to try and sometimes, I think, get people on the hook,” Moore said. "If you allow another country to gain access to really critical data about your society, over time that will erode your sovereignty, you no longer have control over that data."

Your thoughts

China’s love affair with debt is two pronged. On the one hand, the country’s domestic debt threatens to upend the global economy. On the other, building debt traps for developing nations enables China to coerce the developing world.

Let us know your thoughts in the comments section.

Get involved with the discussion and let us know your thoughts on Australia’s future role and position in the Indo-Pacific region and what you would like to see from Australia's political leaders in terms of partisan and bipartisan agenda setting in the comments section below, or get in touch with [email protected], [email protected], or at [email protected]

Beijing’s love affair with debt
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