China's 'Rapid' Debt Buildup May Portend A Looming Financial Crisis: New York Fed

China’s recent debt buildup following the Covid-19 pandemic has researchers from the Federal Reserve Bank of New York wondering if the country can avoid a financial crisis in the years to come.

The consequences of a Chinese crisis may impact the entire globe, as a bad turn for the world’s second-largest economy would likely replicate across most markets.

China had already been playing around with high levels of credit as a way to navigate global and local financial instability. The country acquired substantial debt as a strategy to steer through the years following the 2008 financial crisis and had managed to bring its debt ratio under control by 2018.

Today, it's a different scenario. The pandemic and zero-COVID approach led to the country acquiring almost 30% of its GDP in debt in 2020 alone.

“While other major economies in the world are now tightening their monetary policies, expectations are for overall debt in China to rise again in 2022 to stabilize growth," New York Fed international policy advisors Hunter Clark and Jeffrey Dawson wrote.

Related: China Surprises With Exports Data: What's Triggering A Slowdown Despite Weak Yuan?

By the end of 2021, China’s total credit was almost 290% of its GDP for the nonfinancial sector, including corporate, household and government credit.

The corporate sector has been the largest borrower, taking credit for 153% of GDP. Pandemic-related stimuli were in part responsible for this quick rise in corporate borrowing.

Household debt is also rising to uncomfortable levels. According to the authors, China’s household debt (compared to GDP) is comparable to that of developed economies, standing above the median for the economies in the OECD.

The majority of this household debt — which equals 62% of the country’s GDP — comes from mortgage loans.

China's Financial And Political System

Clark and Dawson suggest that “rapid buildup of debt is often followed by financial crises or at least extended periods of much slower economic growth.”

China’s financial and political system has allowed it to navigate this debt crisis with more success than a classic democratic and capitalist economy would have.

The Communist Party’s ability to influence its own economy is very strong, backed by state ownership of most banks, and several ongoing measures to protect itself from external shocks.

However, like any economy, China is not immune to financial crises.

The current rise in credit is one mark that China’s economy could be contracting. 

Capital-To-Output Ratio

Another factor is the growing capital-to-output ratio. This is the measure of how much the country’s GDP is growing in relation to the capital it injects into the economy, meaning that it’s becoming more expensive for China to grow at the same rates that it has grown in the past.

In a similar way to many other growing economies, China’s population is aging, adding extra weight to an increasingly shrinking working age population.

Current disruption in global supply chains are also a cause for concern for Chinese trade. This could cause China’s export engine to “downshift to a growth rate similar to that of world trade, or perhaps even lower,” say the analysts.

Which Stocks Might Be Affected?

A downturn for the Chinese economy would affect almost every sector, as China has become a major trading partner for most economies on earth, including the U.S. and the European Union.

China is the single largest supplier of imports for the U.S. and the third largest importer of U.S.-made products, making it America’s largest trading partner.

The latest data available puts 758,000 U.S. jobs in question depending on imports and exports with China.

The shock, however, would be felt more directly on Chinese companies and those depending directly on a healthy Chinese economy.

A number of Chinese companies list American depositary receipts in U.S. exchanges. Their stock prices would likely be affected by a financial bust. These include:

• E-commerce, retail, Internet, and technology giant Alibaba BABA
• Electric vehicle makers Nio NIO, LiAuto LI and Xpeng XPEV
• Multinational online travel company Trip TCOM.
• Internet and AI giant Baidu Inc. BIDU
• Farming and food tech developer Pinduoduo PDD.

Image: Shanghai Skyline by Shutterstock.