Abstract: This year, China’s economic growth has been challenged by a series of unexpected events at home and abroad. In a recent interview, Zhang Xiaojing from CASS discusses the risks facing the Chinese economy, and offers recommendations on how to stabilize economic fundamentals and stimulate growth.
I. NO NEED TO BE OVERLY CONCERNED WITH THE RAPID RISE OF LEVERAGE RATIO
Q: China's macro leverage ratio has climbed this year. According to data from the Center for National Balance Sheet (CNBS) of the Chinese Academy of Social Sciences, leverage ratios of government departments, local governments, the household sector, and the real economy have all hit a record high. What is your view on this phenomenon? What does the future trend of macro leverage look like? Are there any issues that require special attention or need to be addressed with extra efforts?
Zhang: I have several basic judgments about the macro leverage ratio. First, the ratio is bound to rise when the economy is down. Second, there is no need to be overly concerned with a rapidly rising leverage ratio. Last, it’s essential to keep a close eye on any signs of a balance sheet recession.
Macro leverage ratio is the ratio of total debt to GDP. When economic momentum weakens, the growth of GDP, the denominator of the ratio, will decline. To stimulate the economy, efforts must be stepped up to increase leverage and sustain debt growth and credit growth, which means the numerator needs to grow at a certain pace. With the increase of the numerator and decrease of the denominator, the macro leverage ratio rises as a consequence.
In terms of the current situation, between stabilizing growth and preventing risks, policy priority should rest on the former, which means that it is acceptable to have a higher macro leverage ratio. At present, China's macro leverage ratio remains low compared with developed countries, but it is much higher than that of emerging economies. So I’m not saying there is no risk at all, but personally I think there is no need to be overly concerned with the rise of the leverage ratio and policy priority should focus on stabilizing growth.
Currently, debt growth rates of many sectors have remained constant and some have even seen a significant fall. For example, the growth rate of total debt in the real economy once reached 30-35%, but now it has fallen to around 10%. Debt growth in the household sector, which hovered around 20% after peaking at 50-60% in 2009, is now less than 10%. That of the corporate sector has also remained at 10%, a level much lower than the high of 30% around 2009.
The debt growth rate in almost all sectors is much lower than its historical highs, and that of the private sector is close to the historical lows. With such debt growth rates, I don’t see the need to worry about the risks brought about by a too rapid rise in leverage.
So I would say in terms of risk prevention, there is no need to worry too much about a debt risk, but it is necessary to keep the balance sheet in check and see if a recession occurs. Currently, we see phenomena such as early loan repayment and suspension of loan repayment. The former will lead to a declining leverage of the household sector, which can be seen as a sign of balance sheet recession, but I think the total amount of early and suspended loan repayment won’t be very large. There is no need to make a fuss with it.
II. LEVERAGE RATIO OF THE HOUSEHOLD SECTOR WILL REMAIN BASICALLY STABLE
Q: Some say the balance sheet of the household sector is, as the buzzword would have it, “l(fā)ying flat”, and even falling into a recession. What is your view on the future trend of it?
Zhang: I don’t see a high possibility of a balance sheet recession of the household sector.
The leverage ratio of the household sector has been rising over the past 30 years. The overall leverage ratio remained relatively stable, at a level of around 62%, despite the recent slight decline, which means that the household sector has not really experienced a balance sheet recession.
Looking ahead, I think the household leverage ratio will stay relatively stable.
First, mortgage loans dominate the household leverage and are closely related to the real estate market. A basic judgment is that the real estate market will not collapse. Although all areas of the real estate sector have fallen sharply in the first half of the year, the government will not allow the real estate market to collapse. As a consequence, mortgage loans will remain at a relatively stable level, and neither substantial growth nor a sharp fall will be seen.
Second, the structure of household loans is changing. Commercial banks have cut back real estate loans in their portfolio, while inclusive finance, loans for self-employed and consumer loans are on the rise. The latter two fall under the category of household loans. In this case, mortgage loans will not fall significantly, while loans for self-employed and consumer loans are rising at a faster pace. In the medium to long term, these changes will help the debt ratio of the household sector remain stable and prevent it from suffering a so-called balance sheet recession.
III. RISK OF BALANCE SHEET RECESSION OF THE CORPORATE SECTOR SHOULD BE CAREFULLY MONITORED
Q: What about the future trend of the balance sheet of the corporate sector?
Zhang: I think it is important to watch out for the risk of a balance sheet recession in the corporate sector. Some argue that given how fast the total leverage ratio climbed in the first half of the year, with the corporate sector contributing 70% of the leverage increase, there is no reason to worry about such a recession. Such argument neglects the composition of the corporate sector. In fact, the leverage rise in the corporate sector in the first half of the year was mainly contributed by state-owned enterprises, while investment and loans of the private sector and private economy have fallen, a phenomenon that requires special attention.
This situation may reflect two issues. On the one hand, some of the enterprises that are short of money cannot get loans, such as real estate companies. On the other hand, private enterprises do not know where to invest their money as they feel uncertain and don’t see good opportunities. This phenomenon is closely related to expectations. There are two factors affecting business expectations, natural factors including the pandemic, and human factors, mainly policy. It is important to avoid campaign-style regulation as it can affect the expectations of enterprises, especially private enterprises. If enterprises feel deeply uncertain about the future, it is possible to see the occurrence of a balance sheet recession.
IV. FINANCIAL INCLUSION AIMS TO PROVIDE THE ULTIMATE PROTECTION FOR THE DISADVANTAGED GROUPS, THE COST OF WHICH SHOULD BE ESTIMATED AND PLAN MADE IN ADVANCE
Q: In recent years, in order to support the real economy, China has introduced a series of policies to increase credit for small and medium-sized enterprises, especially small and micro operators, do you think this will increase financial risks?
Zhang: Small and micro businesses rely mainly on inclusive finance, and there are bound to be risks. But the total size of loans to these businesses is limited, even if there are bad debts, they will not cause systemic risk.
At the core of inclusive finance are universal access, affordable cost, and commercial sustainablility. The issue of risk is associated with commercial sustainability—when the economy is not thriving, there will be risk to commercial sustainability.
The purpose of financial inclusion is to help the micro and small market players survive, in which case it’s inevitable that some of the money lent will never be repaid and become bad debt, raising the non-performing loan rate. And this may be a price that we must pay for cushioning the negative impact of the economic cycle and protecting the market players. The entire financial and monetary system should join together to estimate this cost, which should be accounted for during central government budget planning.
Financial development should be people-centered, and financial inclusion is to provide ultimate protection for the "disadvantaged groups" who are currently excluded from the traditional financial system. Finance has many different roles to serve, each with their own orientations and principles. One of the roles is to provide inclusive finance, and the other is to support innovation, promote scientific and technological self-sufficiency, and maintain financial security. At this stage, to maintain the survival of small and micro market players, and prevent a dramatic fall of the number of market players is to ensure employment and social stability.
Q： To stabilize growth, we need to boost the cycle of production and consumption. Yet the current policy focus seems to be on stimulating production and investment instead of consumption. You mentioned that consumer loans will rise. Will it become an effective tool to spur consumption and facilitate the cycle of production and consumption?
Zhang Xiaojing: The rise of consumer loans is a mid-to-long term trend. For now, investment should play the main role in stabilizing the economy. When the economy is going downward, government investment is the only controllable driving force, since we cannot force households to spend their savings or even borrow more to consume.
Although we hope to reboot consumption to stabilize the economy, it is still a challenging task. Nevertheless, we can rely on investment to drive the economy, while increasing consumption demand to stabilize and stimulate the economy. In this process, personal business loans should aim for preserving rather than expanding the number of market players. These loans can be used by businesses to pay rent and basic operating expenditures, but they cannot boost investment.
As long as proper risk prevention measures are in place, consumer loans will definitely grow in the mid-to-long term, but it is hard to predict the level to which they would rise. In the past, we emphasized a consumption-driven model. Now the focus shifts towards a consumption-driven plus technology-driven model because consumption alone cannot support the new development paradigm.
V. ISSUING MORE DEBT AND LESS MONEY
Q: As economic recovery depends on investment, the central government has rolled out a package of measures and follow-up policies to boost investment. For investment projects like infrastructure construction, in addition to fiscal transfer by the central government, local governments should also provide fiscal support. Do you think there will be a new round of highs in LGFV or hidden debt? After years of debt resolution, what is the current scale of China’s hidden debt?
Zhang Xiaojing: Let’s talk about the scale of hidden debt first. Our research team’s latest estimate is 30 trillion yuan for narrowly defined hidden debt, and 50 trillion yuan when a broader concept is adopted, which is basically consistent with the IMF’s reckoning of China’s hidden government debt. So 50 trillion yuan should be the maximum level.
In terms of infrastructure investment, fiscal transfer by the central government alone is not sufficient. Local governments are tasked with both maintaining economic growth and preventing and controlling the pandemic. Whether the issues facing local governments can be solved depends a lot on economic growth. Besides, the allocation of fiscal power and expenditure responsibilities between the central and local authorities has always been facing a lot of challenges, which requires the central government to take more time to reconfigure the arrangement with an overall strategy in mind.
Given that the current debt ratio of the central government is relatively low, I think policymaking should shift from issuing more money and less debt towards issuing more debt and less money.
Q: It has always been suggested to replace local government debt with central government debt. What is your view on that? And how does the replacement actually work?
Zhang Xiaojing: I think replacing local government debt and LGFV（local government financing vehicle) debt with some of the central government debt may be a solution, but it needs to be carefully considered. Currently, we still need to rely on investment to stimulate the economy, and it is better to expand central government debt instead of local government debt.
As for how to replace debt, it is a technical problem, which requires further evaluation of the overall risk of local government debt. Replacement of local government, which also includes part of implicit local debt such as LGFV debt, entails the assessment of the formation, use, and risks of the debt.
Q: How do you see the role of Shanghai in enabling finance to stabilize growth? What are your suggestions for enhancing Shanghai’s function as an international financial center in global resource allocation?
Zhang Xiaojing: As one of the most financially developed regions in China, Shanghai should be more bold in carrying out trials and pilots.
The current problems Shanghai is facing are still closely related to the previous round of pandemic outbreak. On the one hand, Shanghai needs to maintain pandemic prevention and control; on the other hand, it also needs to stimulate economic growth. We know that Shanghai's financial system is in the hands of a strong management team, and they know very well how to support economic growth and how to strike a balance between pandemic control and stabilization of growth.
Shanghai draws strength from China’s economy as a whole in its pursuit of becoming an international financial center, but it also must rely on the relatively more complex and advanced upstream and downstream industrial chains in Shanghai and the Yangtze River Delta.
In addition, as a pilot zone of high-quality development, Shanghai should embrace innovations in fields like institutions, especially laws and policies. To pursue comprehensive reform, Shanghai should adopt a package of supportive measures. Pioneering institutional innovation in multiple fields will help Shanghai become an international financial center.
Specifically, key areas to be explored include how to align with international standards and how to apply the rules of dispute resolution. On the one hand, we have to borrow from and adapt to international rules. On the other hand, we can also challenge and reshape international rules. In this respect, we can learn from Hong Kong and Singapore. We should make Shanghai a model for China’s institutional opening-up.
