One of the most influential analysts of China’s financial system believes that bad debt is $6.8tn above official figures and warns that the government’s ability to enforce stability has allowed underlying problems to go unchecked.
Charlene Chu built her reputation as China banking analyst at credit rating agency Fitch, where she was among the earliest to warn of risks from rising debt, especially in the country’s shadow banking system.
Today many of her original views — such as concern about Chinese banks concealing risky credit in off balance sheet vehicles — have become consensus among analysts.
“Everyone knows there’s a credit problem in China, but I find that people often forget about the scale. It’s important in global terms,” Ms Chu said in an interview by phone from New York.
Ms Chu left Fitch in 2014 to help launch the Asia operation for Autonomous Research, which specialises in analysis of financial institutions.
In her latest report, Ms Chu estimates that bad debt in China’s financial system will reach as much as Rmb51tn ($7.6tn) by the end of this year, more than five times the value of bank loans officially classified as either non-performing or one notch above. That estimate implies a bad-debt ratio of 34 per cent, well above the official 5.3 per cent ratio for those two categories at the end of June.
China’s problem with borrowing came under the spotlight this week when the International Monetary Fund issued a warning about Beijing’s reluctance to rein in “dangerous” levels of debt.
The fund blamed Beijing’s tolerance of high debt levels on its goal of doubling the size of the economy between 2010 and 2020. “The [Chinese] authorities will do what it takes to attain the 2020 GDP target,” the IMF said.
Ms Chu began attracting attention in 2011 with her proprietary estimates of China’s total debt, in which she supplemented central bank data with her own assessment of hidden credit not captured by official figures.
Ms Chu is among the most bearish observers of China, and some analysts question her methodology. In particular, her estimate of Rmb51tn in bad debt is based on average credit losses across other 11 other economies that previously experienced rapid debt increases comparable to China, including Japan in 1985-97 and the US in 2000-07.
But Chen Long, China economist at Gavekal Dragonomics in Beijing, said this methodology implicitly assumes that an economic crash will eventually occur in China.
Mr Chen argues that credit losses are highly correlated with economic performance: bad loans rise when growth slows. If China can prevent a sharp downturn, credit losses will be much smaller, despite the extraordinary increase in leverage.
“If there’s an economic collapse, of course there will be massive credit losses. No one disagrees about that. But the issue is whether the collapse will actually happen. She takes that as a given,” he said.
He said Ms Chu failed to consider examples such as Korea in the 2000s or Japan after 1997, when debt rose strongly without harming growth.
Ms Chu acknowledges that an acute crisis does not appear imminent. Government influence over both borrowers and lenders has allowed Beijing to delay problems much longer than would be possible in a more market-driven system.
Beijing can order state-owned banks to keep lending to a lossmaking zombie company or to a smaller lender that relies on short-term interbank funding to stay liquid.
But Ms Chu said the ability to avoid recognising losses allows problems to fester for longer — and grow larger — than in an economy where actors respond purely to market incentives.
“What I’ve gotten a greater appreciation for is how everything is so orchestrated by the authorities,” she said. “The upside is that it creates stability. The downside is that it can create a problem of proportions that people would think is never possible. We’re moving into that territory.”