China’s business credit reaches 160% of GDP

Nonfinancial business credit in China has been rising rapidly, supporting GDP growth, but the resulting leverage in the corporate sector makes it increasingly vulnerable to shocks.

According to the US Federal Reserve, non-financial business credit in China has reached around 160% of GDP, a level that is much higher than in most other emerging market economies.

In particular, corporate borrowing has become high in China’s real estate sector, which has been a key driver of China’s rapid growth, and loans for real estate development and related activities have grown rapidly.

In recent years, the Federal Reserve notes, the Chinese government has tightened regulation of real estate markets, including imposing new restrictions on home purchases, banks’ exposure to real estate, and mortgage lending in some markets.

In August 2020, regulators announced additional measures squarely focused on property developers: progressively tighter restrictions on borrowing, based on specific prudential limits on leverage and liquidity (commonly known as “the three red lines”).

In the longer term, these restrictions should help control leverage and increase the resilience of the real estate sector and the financial system.

Not long after these initiatives were implemented, property sales slowed down considerably.

Home prices and construction activity also declined.

Business credit

The Federal Reserve says customers typically make payments to construction companies before project completion, and the adverse dynamic could be amplified if buyers lose confidence in developers’ ability to complete housing units.

There have already been payment defaults by a number of property developers and severe liquidity shortages for others with respect to domestic and offshore financing.

After years of strong growth, domestic bank lending to property developers is declining, and bonds issued by some of China’s largest property developers in the foreign dollar market are trading at increasingly difficult levels this year.

Although the Chinese government has managed to contain its effects so far, a significant worsening of the slowdown in real estate markets could affect China’s financial system.