The campaign thus looks more like a “debt swap” than deleveraging, though less LGFV borrowing may eventually trim government-designated investment, in turn improving efficiency and facilitating overall deleveraging. China’s overall debt of the non-financial sector appears to have broadly stabilized since 2017, after a decade of rapid ascent.
However, we suspect that private firms are likely to bear more of the adjustment pains associated with the latest “deleveraging” campaign. Private companies in China tend to be more efficient but also more dependent on shadow banking, because of their limited and disadvantaged access to the official financial system. The campaign could therefore hurt private firms and corporate earnings harder than those of state-backed zombies.
Our findings show this could depress the ratio of internally generated funds over capex, in turn eventually pushing up corporate leverage and casting doubt on the longer-term sustainability of the campaign. But a fuller picture of the campaign’s impact on corporate earnings will have to wait for another two years.
In any case, for this “deleveraging” campaign to be more sustainable, it needs to be complemented with other restructuring and liberalization programs, such as opening up market competition, speedier exits and entries to weed out zombie firms, trimming the overall weight of the state companies in the economy, and greater efforts to improve the access of smaller and mostly private Chinese firms to credit.
3.2. The longer term: efficiency of investment warrants some caution
Beyond the latest “deleveraging” campaign, what might be the longer-term implications of our core findings for China’s economy?
While it is still too early to tell, as infrastructure projects tend to have long investment cycles, the main message derived from our core empirical evidence is that the expected efficiency of China’s debt-financed investment over the decade following the 2008 global financial crisis at least warrants some caution.
In the end, it brings us back to the legendary Norwegian “Oil Fund”, begging answers to a host of questions that we have not directly addressed yet. Will China’s gigantic infrastructure and other investment programs, whether funded by “corporate” or “government” debt, eventually pay off in terms of higher productivity and sustained economic growth?
More specifically, have the bulk of these investments been sunk into reasonably productive pockets of the Chinese economy? And how well will such sunk-in costs be maintained, managed and utilized in the coming decades? Further, can “China Inc.”, with a more debt-burdened balance sheet, remain resilient against market and economic shocks? Finally, to help put the matter in perspective, while Chinese “corporate” debts must surely have funded some questionable investment projects, would they as a whole fare better or worse than those government debts issued principally to finance pension deficits and current public services in such economies as Japan, some European economies and the US?