PBoC’s Zhou warns China’s leverage is ‘relatively high’

People’s Bank of China governor Zhou Xiaochuan has issued a warning on high leverage in the country’s economy and urged more fiscal reforms to constrain local government debts.

In his speech on October 15 during the Group of 30’s International Banking Seminar, Zhou said the leverage ratio of the economy “as a whole is relatively high” and the main problem lies in a “fairly high corporate debt-to-GDP ratio”.

“People may ask why the corporate sector had such a high leverage ratio and why the financial institutions, especially the commercial banks, were willing to lend so much to them. One of the reasons, as indicated by many economists, is that in China the local governments borrowed heavily through various financing platforms,” Zhou said.

In China, most of the local governments were forbidden from issuing debt and turned to selling land and other off-budget solutions, such as setting up entities known as “local government financing vehicles [LGFVs]”, to finance their infrastructure projects.

Such government borrowing was regarded as corporate debt in statistics, according to Zhou, which is one reason why the debt level of the corporate sector has been overestimated.

Growing significantly in the 2000s, the LGFVs have been labelled as a key risk to the banking system. According to International Monetary Fund data, China’s general government debt was 37% of GDP in 2016. If the figure includes debt of LGFVs and entities such as government-guided funds, “augmented” debt is estimated at 62% of GDP in 2016 and projected to rise to 92% in 2022.

Zhou said it is important to look at the borrowing of local governments, which is related to promoting urbanisation, in order to study the country’s leverage ratio.

Apart from the government debts, excessive credit growth has also been a concern for the country and deleveraging has topped of the government working list this year.

But Zhou said China has entered into a deleveraging process since early 2017 based on money supply and credit expansion figures. “Though the decline is still very moderate, the downward trend has been there,” he stressed.

Lack of transparency

“It is fair to say that in the stage of urbanisation, the fiscal policy transparency is not good enough, the inter-governmental fiscal relationship has yet to be improved, and there is no clear fiscal discipline to constrain the local governments,” the governor admitted.

There is also distortion in the pricing of local government bonds and lending to the financing platforms of the local governments. As a result, the commercial banks and the financial sector have underestimated the risks in the fiscal standing of local governments, he added.

“I believe those issues will be gradually resolved, and the financial market will be more transparent and healthy,” Zhou said, adding that the authorities will address the matter with fiscal reforms.

One of the solutions is the establishment of a financial stability and development committee. Zhou said the work of the committee, which was established in July, will focus on four areas – shadow banking, the asset management sector, internet finance and financial holding companies.

Confidence in GDP growth

In its latest World Economic Outlook, released on October 10, the IMF raised its forecast for China’s economic growth in 2017 and 2018 to 6.8% and 6.5%, respectively – both 0.1 percentage point higher than its previous forecast in July.

Zhou is more optimistic about the growth prospects of the world’s second-largest economy, however. He expects the economy to accelerate by 7% in the second half of the year compared to the 6.9% in the first six months, supported by accelerating household spending. The government’s 2017 GDP target is 6.5%.

The IMF explained that the upgrade “embeds a slower rebalancing of the economy toward services and consumption, a higher debt trajectory, and diminished fiscal space available for crisis”. Yet, it also warned these factors imply a “heightened probability of a sharp slowdown in China’s growth”.