Could China Be the Next Greece?

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Siu Chiu / Reuters

There’s a lot of finger wagging going on in the world about America’s profligate ways. And a lot of comparisons between the budget troubles of the U.S. and the horrors facing Greece. The West, the story goes, stupidly spent  beyond its means while emerging markets wisely saved their pennies for rainy days like these. But the West isn’t the only part of the world grappling with fiscal troubles. Growth darling China has its own debt problems, and some analysts think those could wreak far more havoc on the global economy than what’s going on Greece.

The Chinese government, which just produced its first national audit of local finances, announced this week that local governments could owe as much as 30% of China’s GDP. That’s a good deal more than the government’s official debt load of less than 20% of GDP. And some analysts are putting China’s real debt levels at three to four times those levels.
(Read: Dear Greece, Why Not Just Default?)

The Financial Times reports:

“If you take a very broad view of the Chinese government’s contingent liabilities rather than explicit debt on the books then the number comes to well over 150 per cent of China’s GDP in 2010,” according to Victor Shih, a political economist at Northwestern University in the US.

If the China bears turn out to be right, just how bad could things get? London hedge fund manager David Yarrow said in a recent investor’s letter that Europe’s debt crisis is far less worrisome because people have adjusted to the idea, and so markets know what’s coming. But whether China can handle its debt troubles is still up for debate. And a debt implosion in China would wreak far more damage, partly because it’s not something markets have priced in.
(Read: Hard of Soft Landing for China? How About No Landing)

One reason for that is that no one knows how indebted China really is, since its government is prone to fuzzy math (even fuzzier, perhaps, that the government of Greece). The Economist‘s Ryan Avent chalked up a good graph to estimate China’s total debts in light of the local debt announcement, including what China owes for splashing out on things like high speed rail and bad bank loans. He has some upbeat conclusions to offset the scary new estimates about local debts:

[China's debts are] not much higher than they have been across a period in which the Chinese economy grew extremely rapidly. Yes, local government borrowing soared behind efforts to keep the economy humming through the global crisis. But that rise has been offset by falling national and bank-restructuring bills.

All told, Avent estimates China’s debt-to-GDP ratio is roughly 80%, which, if coupled with China’s expected 5% and 9% over the next few years and fairly conservative spending, would put China back in the black in no time. That’s a lot different than the situation in Greece, where debt levels are equally high, but growth is nowhere in sight and lenders are pulling away. There’s also the fact that, unlike in the U.S. and in Greece, China is toting around some $3 trillion in foreign exchange reserves, which makes it easy to raise money in a flash when times get tough.

But here’s where things get tricky. For China to keep up its growth rate, its consumers must continue to spend. That’s a tough bet if inflation continues to rise. Of course, Avent argues just the opposite. Inflation, combined with China’s “repressed” financial system (it’s not easy for the average Joe in China to get a good loan or find places other than housing to invest), allows the government to easily pay back creditors by siphoning off the savings of its people, he says. An interview I did last year with Princeton University’s JC de Swaan explains how this works:

The government has historically focused on favoring the corporate sector, particularly on its exporters. A good example is the government controls on deposit yields and lending rates. Historically, China has had low deposit yields, which have predominantly hurt households because they’re the savers. And they’ve had low lending rates, which have predominantly helped the corporate sector, and particularly many factories and exporters.

That may help out the government’s balance sheet in a pinch, but it also leaves Chinese consumers struggling to spend more than they already do, which is the key component to China’s growth. Meanwhile, China’s biggest consumers, Europe and the U.S., are headed down the drain. A sharper slowdown in the West, combined with China’s tricky leadership handover next year, could knock down China’s growth rates a good deal lower than many expect. And if there’s anything to be learned from Greece and the U.S., it’s that growing your way out of debt doesn’t always go as planned. China isn’t Greece yet, but it isn’t out of the clear either.

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