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China’s leveraged consumers

By Ichiro Suzuki China has been well known for its accumulation of debt in recent years. The country already passed the U.S. in one measure of debt, and catching up in another. The ratio of household debt to disposable income has topped 100% and is reaching 125% whereas this ratio for the U.S. has been in steady decline since the global financial crisis, and is down to almost 100% from 125% ten years ago. The ratio of household debt to GDP has also been climbing steadily for China to 50%, doubling from less than 25% ten years ago. This ratio is approximately 75% for the U.S., coming down from almost 100% during the same period. The problem for China is not only fast accumulation of debt but also its fierce building-up for the country’s relatively less developed stage of the economy. For China per capita GDP is still less than $10,000 ($9,600 to be specific) in 2018 according to the IMF, in contrast to $62,600 for the U.S. One would never know how much of debt the Chinese household sector would rack up by the time their income reaches the level of developed countries. Or if they cannot keep relying on perpetual and fast expansion of debt, the household sector could become significant headwinds to the Chinese economy. Going forward China will have to rely on the household sector, or consumption in other words, for economic growth, since the most of what’s needs to be built has been already been built in infrastructure development. There will still be roads, bridges, railways, ports and airports to be built of course, but those that will be built in the coming years and decades will not generate as much economic growth as the past project did. During the years of frenetic infrastructure development, Beijing has systematically suppressed personal consumption so that massive savings in the household sector could be diverted to public works. In fact, consumption accounted for less than 40% of  China’s GDP, far cry from 70% for the U.S. The number for the U.S. is a little outrageous and 60% is more often seen among developed countries. For China’s consumption to be lifted by 20% in relation to GDP, one wonders how much debt would the household sector would have to accumulate from 120% of GDP today. It would certainly go into an uncharted territory not even experienced in the U.S. in the first decade of this century. Or would high debt levels at some point become impediments to further economic development, containing China in the middle income trap that have caught a number of developing countries? Then, coronavirus is hitting the global economy hard. While it is still too early to assess its full impact, it is likely to exert considerable downward pressure on the long-term health of the global economy. China and Asia might come out of this crisis with relatively ‘modest’ damage compared to the United States and Europe. Nonetheless, China’s long-term growth rate, already descending in recent years, is almost certain to go lower than would otherwise has been the case without coronavirus. At possibly around 3%, China is expected to register the lowest growth rate in the post-Mao era. This alone makes it harder for Chinese consumers to rise to the levels they aspire. Then, many people would not come off this crisis unscathed, either losing a job, being forced to accept a pay cut or suffering significant losses in their own business. Worse, corrections in the financial markets, in equities, commodities and real estate, are severely hitting the balance sheets of corporations and households. For households, value of their investments in stocks and houses are materially lower than they were just a few months ago. If they borrowed money to buy a house, that makes it even worse. Both Corporate China and the household sector would spend the next several years on reconstruction of their balance sheets, and hence suppressing growth. In fact, this process is what Japan went through in the 1990s after the bubble’s burst at the outset of the decade.  Japan at that time was the most heavily-indebted major economy, and this dubious distinction belongs to China today. As a consolation prize, weak income growth and damaged balance sheets would bring down Chinese tourists’ consumption overseas, the single largest negative factor on China’s external account. As Chinese tourists stay home, a cap is placed on this large hole. Nonetheless, China’s leveraged consumers would find it hard to rise much higher. 

About the author: Mr. Suzuki is a retired banking executive in Tokyo, Japan, who sits on a number of boards of universities.

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