China urgently needs a plan to address a build-up of corporate debt that is manageable but with a window to address it “closing quickly,” according to an International Monetary Fund working paper.
The rapid increase of debt since the global financial crisis has left China with a credit gap comparable with those experienced previously by countries such as Thailand, Spain and Japan that subsequently experienced “painful deleveraging,” said the paper by IMF staffers. China's risks appear high but are manageable if the problem is addressed promptly, it said.
The working paper's warning adds to a drumbeat of concern over a surge in corporate debt that coincides with dwindling economic returns as the nation gets less growth for each buck of credit. China's government released guidelines last week for reducing debt and said it won't bear final responsibility for borrowing by companies.
“International experiences suggest that credit booms of this size increase the risk of slower growth or a disruptive adjustment,” said the IMF staffers. “The authorities recognize the problem, but appear to be still searching for a comprehensive, proactive, strategy.”
Potential Losses
Potential debt at risk is estimated to be about 15.5% of the total corporate loan portfolio as of end-2015, which could yield estimated potential losses of about 7% of GDP, the authors conclude. The IMF staff estimate that exiting from loss-making firms would cost 7.8 million jobs — 2.8 million in overcapacity sectors like coal and steel and 5 million in construction.
Cuts to overcapacity would likely take time and displaced workers will be gradually absorbed into new sectors, the authors said. The net impact on GDP of sector consolidation is estimated to be a loss of 0.6% in the first year, 0.2% in the second, close to zero in the third and a boost of 0.2% in the fourth, the paper estimated.
China's total debt grew 465% over the past decade, according to Bloomberg Intelligence. Total debt rose to 247% of gross domestic product in 2015, from 160% in 2005, with corporate debt jumping to 165% of GDP from 105%.
The corporate debt problem should be addressed urgently with a comprehensive strategy, the paper said. That should include identifying companies in financial difficulties, proactively recognizing losses in the financial system, burden sharing, corporate restructuring and governance reform, hardening budget constraints and facilitating market entry, the authors said.
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