Since 2008, debts owed by China’s nonfinancial sector have soared by more than 90 percentage points relative to GDP. As David said, that’s “pretty damn fast.”

Almost all of that increase can be attributed to corporate borrowers. Chart via Goldman:

Chinese corporations are now among the most indebted in the world. For perspective, Japanese nonfinancial businesses took ten years to increase their indebtedness by 30 percentage points of GDP in the 1980s. Via Nomura:

Who has been doing the lending?

Despite the excitement surrounding the growth of “shadow” banking in China, Goldman estimates that about 70 per cent of the total increase in credit has come from the big state-run institutions. Similarly, about two thirds of the outstanding stock of non-financial corporate debt takes the form of bank loans or bonds.

Credit provided by investment trusts and ostensibly non-financial businesses (“entrusted” loans) only accounts for about 15 per cent of total non-bank corporate debt. These lightly-regulated forms of borrowing are responsible for only a slightly larger share — about 22 per cent — of the funding raised by local government financing vehicles:

Another popular concern is the rapid growth of debt denominated in dollars. The Bank for International Settlements recently wrote about this subject (as did we) and found that Chinese non-bank borrowers owe a little more than $1 trillion — up from about $200 billion in 2009:

That sounds like a lot, but this foreign currency debt is worth less than 4 per cent of the total. It isn’t obvious to us how much it matters for China’s financial stability and growth prospects, although a lot of that depends on how the debt is distributed.

Who are the big borrowers?

Among publicly-listed non-bank corporations, Goldman finds that about 30 per cent of the debt is owed by companies in real estate, construction, and engineering. Another 22 per cent is owed by businesses in oil, gas, metals, and mining:

The unwell state of the Chinese property markets and the dire state of the industrial commodities business might suggest that many lenders won’t get repaid (in nominal terms, anyway), although we wouldn’t want to bet against the government’s ability to paper over bad debts by taking wealth from the beleaguered household sector.

Speaking of which, most of the additional debt has been incurred by state-owned enterprises that benefit from preferential access to credit, rather than productive borrowers in the private sector. This artificially cheap capital — provided by household deposits — subsidises inefficient businesses and creates excess capacity.

As you can see in Goldman’s chart below, SOE indebtedness (the grey bars) has soared since 2007 even as their already-meagre returns on assets fell. By contrast, private enterprises were cutting their leverage and boosting their profitability:

Another way to see this is to look at the change in leverage across companies by size. Since 2008, the companies that had the most debt have been taking out more while the ones with the least debt have been retrenching:

Goldman estimates that “the allocation of investment to less efficient SOEs has cost China about 1-2pp in GDP terms.”

It’s possible that reforms are starting to have a modest impact on credit allocation. Spreads between lower-rated and higher-rated bonds have widened considerably since 2012:

Of course, bonds only fund a little less than 8 per cent of non-bank corporate borrowing, according to Goldman, so you shouldn’t read too much into this. Until the banks — which themselves are creatures of the state — start making loans on the basis of profitability and creditworthiness rather than political considerations, the household sector will continue to see its modest savings misdirected into dubious projects.

Related links:
China: Overborrowed and overbuilt — Financial Times
Shenzhen and the art of balance sheet maintenance — FT Alphaville

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