2020 could see the collapse of China’s financial system.

 

By now all experts concur that post coronavirus, the world economy will not be the same and will take at least four-six quarters to recover. The over $14 trillion Chinese economy—second largest in the world—is also set to be completely altered, with some experts saying the setback could be permanent. For decades, China has been powering global manufacturing through its integrated supply chains on the back of large amounts of debt. Troubles are mounting for China since its years of profligacy on borrowed money has now resulted in its debt pile becoming extremely large at a time when its economy is contracting.

As per Institute of International Finance, China’s total domestic debt hit 317% of its GDP in first quarter of 2020, up from 300% last year, registering a largest quarterly increase. What’s worse, this data under-reports the true picture of China’s indebtedness, since a lot of debt is taken by local governments through financing vehicles that are not reflected in balance sheets. Since 2008, the annual growth in China’s domestic debt has been 20%, which has outpaced its GDP growth. Add to it the political culture of central Chinese leadership being favourably disposed towards local governments that have shown “development” backed by an ever increasing debt burden.

And China is set to take on more debt as it tries to beat the Covid-19 induced slowdown to increase its spending. With Beijing announcing advance quota of local government special purpose bonds to the tune of 1 trillion yuan to fund infrastructure projects, it is now almost a given that debt at the local level—which is non-transparent and often violates banking rules—is set to balloon further. The move will ensure local government debt will more than double as compared to last year from 1.9 trillion yuan in 2019 to almost 3 trillion yuan this year.

A banking crisis and systemic collapse of the financial sector are now looming large amidst growing concerns that many of the debts taken at household level and at local government level are at a very high risk of default. This could hit China’s state-dominated financial system hard and unravel the non-transparent financial dealings that have been the hallmark of its growth model. In fact, the extent of regulatory lapses can be gauged from the fact that Ministry of Finance has been forced to call out certain regional governments for illegal fundraising in multiple audit reports. Obviously, the pandemic will slow regional economies and will drive down revenues of local governments, which will limit their ability to repay/refinance previous large amounts of debt, leading to large scale defaults.

One round of bailout by the central government took place in 2019 as smaller Chinese banks were witnessing tremendous uncertainty. There are now expectations that many more Chinese financial institutions will need bailouts by the central government.

Earlier this month, MIE Holdings, a listed oil and gas company, failed to make a $17 million interest payment on its $248 million bond, indicating the pain that lies ahead for Chinese companies. The pain will ultimately be felt by the government, which has asked its banks to extend borrowing to small businesses since this will add more bad debts to the financial system going forward due to a poor economic scenario.

The world’s most indebted country is shovelling more money via debt to fund projects to bring back growth. 2020 will decide whether the Chinese growth model will unravel and lead to its collapse. For now, bond markets and investors around the world are on tenterhooks.

Gaurie Dwivedi is a senior journalist covering economy, policy and politics.