Control China’s Macro Leverage

By Chang Xin

International rating agency Moody released a report on January 8 that most of the 53 rated Chinese state-owned enterprises will gradually reduce their leverage ratio in 2018.

Liu He, director of the Office of the Central Leading Group of Finance, said during the Winter Davos 2018 that China will strive to effectively control the macroeconomic leverage over three years. The 19th National Congress of the Communist Party of China regards “prevention and mitigation of major risks” as the first phase of “three major battles” to be fought in order to succeed in building a moderately prosperous society.

When analyzing and studying the 2018 requirement to effectively control macro-leverage, subsequent meetings of the Political Bureau of the CPC Central Committee clarified the first objective as “preventing and resolving major risks”.

To achieve this goal, it is necessary to effectively control the leverage ratio of household, the non-financial sector, the financial sector, and government departments, especially local government departments.

Effective Control of Household Debt

At the end of 2017, outstanding household debt was 40.5 trillion yuan, accounting for 49% of GDP.

Looking at the change, we can see that it has increased significantly by 9 percentage points in the two years since 2016.

According to comparable data for the second quarter of 2017 released by the Bank of International Settlements (BIS), China’s household debt accounted for 46.8% of GDP, which was significantly lower than the 61.3% of all reporting economies and the 75.4% in advanced economies. (Based on the exchange rate method).

Nevertheless, the rising leverage of China’s households deserves great attention. In fact, the obvious rise in domestic debt is becoming a global issue.

According to the Global Financial Stability Report released by the International Monetary Fund (IMF) in October 2017, the household debt ratios of advanced economies and emerging market economies have continued to rise since the financial crisis.

In 2008-2016, the median share of household debt in developed economies rose from 52% to 63% of GDP, while in emerging economies the figure rose from 15% to 21%.

The report pointed out that while increasing household debt will be conducive to economic growth in the short term, it will do harm to macroeconomic and financial stability in the medium term, which will negatively affect economic growth, consumption, and employment as well as increasing the risk of banking crises. Therefore, we need to strengthen our macro-prudential and financial regulatory policies.

In order to effectively control the added-leverage of household debt, China’s regulatory authorities conducted strict control over individual housing loans in 2017. In the year, the balance of personal home loans of major financial institutions increased by 22.2% compared with the same period of previous year, a drop of 12.8 percentage points from the end of 2016.

Strict Supervision of Consumer Loans

In the meantime, household consumer loans, marked by a great acceleration in growth since the third quarter of 2017, have also been heavily regulated.

It is expected that household consumer loans will remain under strict supervision in 2018 and the growth trend in the household sector may be contained.

Effectively Control Non-Financial Sector Debt Ratio

At the end of 2017, non-financial corporate sector debt was 126.2 trillion yuan, accounting for 152.6% of GDP.

This ratio has gradually stabilized or even declined since 2016.

In order to consolidate this trend, the National Financial Work Conference held in 2017 further proposed that state-owned enterprises deleveraging should be the priority. This is based on the following considerations:

Firstly state-owned enterprise (SOE) debt accounts for about 60% of total corporate debts.

Secondly, state-owned enterprises’ asset-liability ratios were the worst of all the different ownership types.

Thirdly, there is no obvious improvement in the assets/liability ratios of the state-owned enterprises.

To resolve the problem of high leverage in state-owned enterprises, deeper reform is required, starting with efficiency improvements and restoring the balance sheet of this sector.

Improving the Efficiency of State-owned Enterprises

On one hand, it is necessary to further improve the profitability of enterprises and reduce the amount of debt per unit output.

On the other hand, it is important to further optimize the allocation of corporate debt funds and resolutely shut down “zombie business”.

Tighten Local Government Budget Constraints

At the end of 2017, the outstanding central government bonds was 14.14 trillion yuan (fourth quarter data has not yet been released as the actual amount of the national bonds outstanding). Local government debt was 16.47 trillion yuan (of which 14.74 trillion yuan was government debt, and non-government bonds was 1.73 trillion yuan). The overall government leverage ratio was 37%.

The trend of the government leverage ratio appears stabilizing and declining gradually since the implementation of the newly revised “Budget Law”.

However, it is worth noting that while explicit debt growth is under control, a number of new financing instruments have been adopted by government investment funds, special construction funds, government procurement services, and government and social capital cooperation (PPP) projects to circumvent regulations, which has increased the risk of hidden debt.

In response to the new situation and problems in the debt financing activities of local governments, the Ministry of Finance issued a series of documents in 2017 to prohibit local governments from using disguised financing such as non-standard PPP modes, government investment funds, and government procurement services.

The National Financial Work Conference held in 2017 targeted lifelong accountability for local debts for the first time, sending a red alert on risk control of local debt.

Control the Government Leverage

In the next stage, substantive progress must be made in managing the debt risk of local government. In addition, fundamental adjustments must be made to the current system of government resource allocation, investment and financing, the fiscal and taxation system, and the financial system. In particular, deeper reform should be carried out to tighten budgetary constraints on local government.

Effective Control of the Financial Sector Leverage

In 2017, financial deleveraging accelerated in the fields of interbank, financial management, and off-balance sheet operations.

First – Monetary Policy. The People’s Bank of China has cut short-term capital supply and increased long-term capital supply. It has also raised interest rates several times to reduce liquidity.

Second-Regulatory Policy. The main measures include: putting the bank’s off-balance sheet wealth management into macro-prudential assessment of MPA’s generalized credit indicators; conducting special governance on illegal activities such as supervision / transaction / charging and so on; strengthening the unified supervision of assets and resources and reducing arbitrage space.

According to the information disclosed by the financial regulatory authorities at for the end of 2017, there was a fall in banking liquidity, and a steady decline in the leverage ratio in the financial sector. More than 100 banks reduced their total banking assets, with the growth rate falling 7.1 percentage points year on year. Interbank assets and liabilities shrank for the first time since 2010. Bank financing increased by less than 5 trillion yuan, and interbank financial wealth decreased by 3.4 trillion yuan compared with the beginning of the year. Investment in “special purpose sectors” will be increased by less than 10 trillion yuan. The overall growth rate of off-balance sheet business dropped month by month.

Since the start of 2018, regulatory authorities have again adopted a series of intensive financial supervision measures; At the same time, the PBOC assessed the percentage of deposit certificate in MPA’s inter-bank liabilities over one year, which is released by banks with an asset size of over 500 billion RMB. It is expected that under the neutral monetary policy and strong financial regulatory measures, deleveraging within the financial system will continue to make solid progress.

Chang Xin, Researcher in Institute of Economics in Chinese Academy of Social Sciences.

The article reflects the author’s opinion, and not necessarily the view of China Matters.

Edited By Cai Hairuo