Earlier this week Standard and Poor’s released a headline-grabbing report on global corporate borrowing. The report estimates that there will be $53 trillion in new corporate borrowing between now and 2017. Of that $53 trillion, Chinese corporations will account for a whopping $17.6 trillion, 33 percent of the total.
When you dig into the details you see that the report gives both a high and a low estimate for debt growth over the period. The low estimate is still quite high, 15.6 trillion in new borrowing compared to 17.6 in the high estimate. The low estimate assumes that debt will grow at the same rate as nominal GDP over the period, 11.5 percent (8.4 percent real). The high estimate assumes that corporate debt will grow at 1.2 times the nominal GDP growth rate.
The projected growth in debt demand as well as the remaining stock of existing debt implies a debt-to-GDP estimate for China in 2017 in the 136 to 150 percent range. There are, however, some problems with this methodology. The nominal growth rates are based off the IMF’s April World Economic Outlook projections. Given the recent spate of growth downgrades by most analysts, it’s likely that the IMF’s projections for China are a bit on the high side. So while corporate debt may very well grow faster than the nominal GDP rate, nominal GDP growth is likely to be lower than the IMF’s projected 11.5 percent.
Nevertheless, the scale of new borrowing over the next five years is staggering. Even at the low estimate, Chinese companies will borrow 24 percent more than what S&P estimates companies in the United States will borrow. This is quite unusual given that these same projections show that the US economy will still be 50 percent larger and with a much higher level of per capita income. The positive relationship between per capita income and levels of credit is well-established, with financial deepening occurring as countries develop.
As we’ve noted many times before on this blog, the artificially low cost of capital in China incentivizes excess borrowing. With both lending and borrowing interest rates below what would prevail at market levels, credit to GDP has grown rapidly in recent years.
One way to estimate the degree of excess borrowing that will be undertaken by Chinese corporations over the next five years is to look at the corporate debt to GDP ratios of China’s economic comparators. The average corporate debt to GDP ratio for the BRICS (excluding China) is 75 percent. Taking the lower estimate for China from the Standard & Poor’s report (136 percent) and calculating the difference in borrowing if China adhered to the BRICS average results in an estimate of $8.2 trillion in excess borrowing. This is over 50 percent of China’s projected borrowing in the 2013–17 period.
As a spot check, let’s substitute in a different country as a comparator. South Korea, has followed a similar economic development model to China, but is considerably more developed economically. It currently has a corporate debt to GDP ratio of around 100 percent. Assuming that China should borrow at a rate similar to South Korea, over the next five years there will be $4.8 trillion in excess borrowing. This is over 30 percent of China’s projected borrowing in the 2013–17 period.
None of this is to say that China is on the verge of a debt meltdown. Many Chinese enterprises, especially private enterprises, have relatively healthy interest coverage ratios. It does, however, call attention to the sheer volume of corporate debt that is on pace to be issued over the next several years. If you believe that market interest rates are important to allocating capital correctly, you should be concerned at the scale of debt being issued in a distorted environment.