China's Credit Growth: A Slowing But Still Aggressive Rhino
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China's Credit Growth: A Slowing But
Still Aggressive Rhino
Primary Credit Analysts:
Terry E Chan, CFA, Melbourne (61) 3-9631-2174; terry.chan@spglobal.com
Christopher Lee, Hong Kong (852) 2533-3562; christopher.k.lee@spglobal.com
Secondary Contacts:
Qiang Liao, PhD, Beijing (86) 10-6569-2915; qiang.liao@spglobal.com
Lawrence Lu, CFA, Hong Kong (852) 2533-3517; law.lu@spglobal.com
KimEng Tan, Singapore (65) 6239-6350; kimeng.tan@spglobal.com
Ryan Tsang, CFA, Hong Kong (852) 2533-3532; ryan.tsang@spglobal.com
Christopher Yip, Hong Kong (852) 2533-3593; christopher.yip@spglobal.com
Research Assistants:
Mabel Chen, Melbourne
Wenyi He, Hong Kong
Jiewei Xu, Beijing
Table Of Contents
Our Base Case: Hold On To Your Hats For 77% Debt Rise
Pessimistic Case: Debt Would Double
Optimistic Case: Debt Will Rise 59%
A Closer Look At China Inc.'s Major Debtors
Don't Forget The Black Swans
Footnote
Related Research
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1923339 | 301135083China's Credit Growth: A Slowing But Still
Aggressive Rhino
To its credit, China is facing up to some hard truths. The "People's Daily" newspaper, a government mouthpiece,
recently warned about the dangers of "gray rhinos." The metaphor, first coined by policy analyst Michelle Wucker (see
footnote), describes highly probable threats that everyone can see but are choosing to ignore, with potentially
catastrophic consequences. For China, the herd includes overheating property markets, ever murkier "shadow
banking" activities, and industrial inefficiencies. And the biggest rhino of all is its rampaging debt levels. S&P Global
Ratings estimates that China's debt could rise a hefty 77% to Chinese renminbi (RMB) 302 trillion (US$46 trillion) over
2017-2021. But that also means the pace of growth will at least be slowing down.
So, just how risky is China's debt trajectory? Risky enough for S&P Global Ratings to downgrade China on Sept. 21,
2017, citing increasing economic and financial risks from a prolonged period of strong credit growth (see "People's
Republic Of China Ratings Lowered To 'A+/A-1'; Outlook Stable," published on RatingsDirect on Sept. 21, 2017). The
next day, for the same reason, we lowered China into group '6' from group '5' under our "Banking Industry Country
Risk Assessment." And a month earlier the IMF warned: "International experience suggests that China's credit growth
is on a dangerous trajectory."
Overview
• China's growing debt burden is increasing its economic and financial risks, and underpinned our recent
lowering of the sovereign credit rating to 'A+/Stable/A-1'.
• Our base-case projection is that China's overall credit growth could rise a hefty 77% to RMB302 trillion (US$46
trillion) over 2017-2021.
• That would mean average credit growth will have dropped a third to 12% each year for the five-year period
ending 2021, but the rate is still above that of nominal GDP.
• We expect the central government to help limit the losses for banks despite the elevated private sector debt
leverage.
• Our view reflects China's continuous efforts to stabilize corporate debt leverage, assume certain credit losses
through LGFE debt swaps, and control property price run-ups.
Right now, we think the growth trend appears to be at an inflexion point. The central government's efforts to curb the
surging leverage of state-owned enterprises (SOEs) and local government financing entities (LGFEs) should start to
bear fruit. As the economy rebalances more towards consumption from heavy-industry investment, household debt
will likely rise faster than those of the corporate and government sectors.
We see the IMF's projected debt levels (see chart 1) as being close to our pessimistic-case forecasts. Our base-case
projection is that China's average credit growth will drop a third to 12% annually for 2017-2021. Despite this
slowdown, the rate is still above our projection for nominal GDP, implying that the system's high credit risks could still
incrementally increase. Therein lies the danger.
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Chart 1
Our Base Case: Hold On To Your Hats For 77% Debt Rise
Our base case assumes that China's leverage--as measured by a ratio of credit to GDP--will rise 12% to 257% within
five years. Total debt will likely increase to RMB302 trillion by 2021 from RMB171 trillion last year (see chart 2). This
slowing growth rate suggests the government's efforts to deleverage corporates have started to bite.
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Chart 2
Household debt: Up 26% by 2021
We project that households will account for 22% of China's overall debt this year (see chart 3). Over the next five
years, households' ratio of credit to GDP is likely to rise 26% (or 13 percentage points) to 63%, compared with a ratio
of 50% last year (see chart 4), driven by continuing urbanization.
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Chart 3
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Chart 4
Corporate debt: Up 6% by 2021
We estimate that China's debt-hungry corporates account for a whopping 49% of the overall debt mix in 2017. The
large debt load relates to the former investment-heavy economic development model that the Chinese government has
adopted. In our base case, we assume the government's deleveraging directives will rein in credit growth to a much
slower rate of seven percentage points (or 6%). The ratio of credit growth to GDP will therefore rise to 120% by 2021,
compared with 113% last year (see chart 5).
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Chart 5
Private vs. public: Up 12% vs. 10%, respectively, by 2021
We estimate that private sector debt will collectively rise by 20 percentage points (12%) to reach a credit-to-GDP ratio
of 183% by 2021 from 163% (see chart 6). This is the result of our estimates for the two components of household and
corporate credit. Meanwhile, a crackdown on local government lending should push up general government debt by
10% to 74%, from 67% in 2016 (see chart 7).
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Chart 6
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Chart 7
Pessimistic Case: Debt Would Double
For our pessimistic scenario, we raised the "credit intensity" multiples by one-fifth. Consequently, with credit growth
continuing almost unabated, the ratio of credit to GDP grew 58 percentage points (25%) to 288% (see chart 1). That's
very close to the IMF's projection. At this level, China's total debt would have doubled to RMB338 trillion from
RMB171 trillion (see chart 8). The IMF suggests debt will rise 86% by 2021 to RMB359 trillion.
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Chart 8
Optimistic Case: Debt Will Rise 59%
For our optimistic scenario, we reduced the credit intensity multiples by one-fifth. This level assumes the corporate
deleveraging efforts substantially succeed, pushing up the credit-to-GDP ratio by just 1% to 232% over 2017-2021 (see
chart 1). Under that scenario, China's total debt would increase 59% to RMB272 trillion, up from RMB171 trillion in
2016 (see chart 9).
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Chart 9
A Closer Look At China Inc.'s Major Debtors
Corporate financial risk is still aggressive. We took a sample of the 2011-2016 financials of 2,298 nonfinancial
corporates (rated and unrated) from the database of S&P Global Market Intelligence (CapIQ). Of this sample, total debt
for 2016 represents about a quarter of China's total nonfinancial corporate debt of RMB85 trillion.
Let's look at the leverage trends first. For the sample, we computed two leverage ratios: debt to EBITDA and funds
from operations (FFO) to debt. In 2016, the sample's average debt-to-EBITDA ratio stabilized but in a category we
classify as aggressive or highly leveraged (see chart 10). However, the median was significantly better and has been
steady for some years. Similarly, average FFO-to-debt ratios stabilized in 2016 albeit at an aggressive level (see chart
11). On the other hand, the median improved slightly (back to 2014 level).
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Chart 10
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Chart 11
Next we looked at the sample's risk trends. Over the past three years (2014-2016), changes in the ratio risk-category
distribution have been both up and down. On a debt-weighted basis, some high-risk categories (e.g. debt-to-EBITDA
ratios that are at a highly leveraged level) are higher while the negative category is lower (and therefore better) (see
charts 12-13). On a debt-weighted basis, more than 75% of the sample's financial ratios are aggressive (the fifth of six
categories) or worse. Less than 60% of sample is highly leveraged (the sixth and worst category).
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Chart 12
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Chart 13
We should qualify here that the sample is likely to include LGFEs. The LGFE sector has been one of the
fastest-growing and risky classes of credit, but an ongoing debt-for-government bond swap program is a mitigating risk
factor.
Don't Forget The Black Swans
The recent intensification of government efforts to rein in corporate leverage could stabilize the trend of financial risks
over the next few years. But we still foresee that credit growth will remain at levels that will gradually increase
financial stress. And that's without added shocks.
"Black swan" events are abnormal occurrences that could have a catastrophic impact. By definition, these are hard to
predict, but two such scenarios for China would involve either over-acceleration of growth or a disorderly deceleration.
And either could undermine market confidence and loan performance, pushing up volatility and liquidity stress.
In our view, potential credit losses for the banking sector from disorderly deleveraging are unlikely to be worse than
our current assessment. We expect the central government to help limit the losses for banks despite the elevated
private sector debt leverage. Our view reflects China's continuous efforts to stabilize corporate debt leverage, assume
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1923339 | 301135083China's Credit Growth: A Slowing But Still Aggressive Rhino
certain credit losses through LGFE debt swaps, and control property price run-ups.
Nassim Nicholas Taleb's black swan theory predates the global financial crisis in 2008, when warning signs were
missed. We believe China is now in the midst of a debt crisis. And it's one that we feel is chronic rather than acute.
Footnote
• "The Gray Rhino: How to Recognize and Act on the Obvious Dangers We Ignore," Michele Wucker, St. Martin's
Press, 2016, ISBN-10: 125005382X, ISBN-13: 978-1250053824
• "The Black Swan: The Impact of the Highly Improbable," Nassim Nicholas Taleb
Related Research
• Research Update: People's Republic Of China Ratings Lowered To 'A+/A-1'; Outlook Stable, Sept. 21, 2017
• China's BICRA Lowered To Group '6' On Rising Credit Risks, Sept. 22, 2017
Only a rating committee may determine a rating action and this report does not constitute a rating action.
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1923339 | 301135083Copyright © 2017 by Standard & Poor’s Financial Services LLC. All rights reserved.
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