In the past decade, China’s total debt as a percentage of GDP has almost doubled, with most debt concentrated in China’s corporate sector, especially in large state-owned enterprises (SOEs). Financial deleveraging has been among key goals outlined in President Xi Jinping’s second term. Risks are accumulating, as 2018 has already been an almost record year for corporate bond defaults. But now, findings in a report by S&P Global Ratings suggest that the amount of debt that Chinese local governments keep off their balance sheets may even total up to multiples of the publicly disclosed amount. Local government financing vehicles (LGFVs) have accumulated much of this hidden debt. While firm plans are needed to reduce these debts, progress has been limited so far. Both local governments and LGFVs are walking a tightrope between deleveraging and transforming their businesses into more typical SOEs. Including hidden debts, the ratio of all government debt to GDP may have reached 60% in 2017, an alarming level. Furthermore, the report anticipates that local government support to LGFVs will weaken, therefore S&P has lowered long-term issuer credit ratings on seven vehicles to reflect such transitional risk.

Next to soaring debt, China is currently dealing with slowing growth. This month, China published that its economy expanded 6.5% year-on-year in the third quarter, marking China’s weakest quarterly growth figure since the depths of the 2008 global financial crisis. Chinese policy makers will need to use different tools to maintain economic growth. For decades, China bolstered economic growth by pouring trillions of dollars into infrastructural projects, but from the start of the year until now, the growth in infrastructure spending has already fallen sharply. Instead, tax cuts and other fiscal stimulus measures are playing an increasingly large role in the efforts of Chinese policy makers to prevent the world’s second-largest economy from slowing further.

Most importantly, slowing growth and mounting debt are decreasing the superpower’s leverage in the current trade war with the U.S. In September, the U.S. imposed tariffs on $200 billion in goods from China, increasing the pressure on President Xi Jinping and his administration to deal with the effects. Recently, leaked documents showed how the government urged state-owned media to handle sensitive business data with care, especially ‘worse-than-expected data’ that could show the economy is slowing, local government debt risks, or the impact of the trade war with the U.S. Chinese authorities, however, insist that its economy is “highly resilient” and Beijing is not afraid of a trade war. Either way, U.S. President Trump has expressed he does not intend to step back from the trade war, and so the pressure on China will remain. This means that now Beijing is fighting a war on two fronts: at home, trying to cut debt and on the border, trying to face an aggressive enemy in the form of the Trump administration.

In the broader scheme of things, the trade tensions have fueled pessimism about the global economy, having negative effects on emerging markets.


RISKS MARKED ON THE RISK RADAR AS NUMBER 3: Chinese / other EM’s economic slowdown

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