Immediately after Standard & Poor’s rating agency announced its historic downgrade of U.S. sovereign debt last Friday, China’s official Xinhua news agency published a scathing editorial, excoriating the profligate western nation for its “debt addiction”.
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“The U.S. government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone,” it thundered, as it reminded Americans that China was the largest foreign holder of their government’s debt.
The implicit assertion behind this fierce outburst was that China, in stark contrast to the U.S., was a country that understood “the commonsense principle that one should live within its means”.
Indeed, the Chinese central government’s declared gross debt was only about 17 percent of gross domestic product at the end of 2010 — tiny when compared with the debt-to-GDP ratios for the U.S. (87 percent), U.K. (80 percent) and Japan (210 percent).
S&P and its competitor Moody’s both upgraded China’s sovereign rating at the end of last year, with S&P citing Beijing’s modest indebtedness, a strong external asset position and the economy’s rosy outlook.
But the Chinese government is not quite the frugal, prudent borrower it portrays itself to be.
When assessing a country’s real debt situation, rating agencies usually use a concept known as “general government” debt. This includes the liabilities of central and local governments as well as social security funds. Most debt ratios for developed economies such as the U.S. are calculated in this way.
In the wake of the 2008 financial crisis, China’s local and regional governments went on an infrastructure building spree that saw them run up huge debts, usually channeled through special-purpose financing vehicles that allow them to get around laws requiring them to keep balanced budgets.
Various parts of the Chinese government have different estimates of the total size of local government debt, but one of the more authoritative figures puts it at about 37 percent of GDP at the end of last year, according to the GaveKal-Dragonomics economic research firm.
By including a range of other liabilities that Beijing is explicitly or implicitly on the hook for — such as ballooning debt at the railway ministry, bonds issued by so-called policy banks that lend on behalf of the state, and bad debts in the state-owned banking system — GaveKal-Dragonomics estimates that China’s real debt-to-GDP ratio could be as high as 90 percent.
Other analysts believe the total is more like 70-80 percent, and Fitch Ratings makes a conservative estimate of about 48 percent gross general government debt by the end of last year, based on the opaque and incomplete information available.
The main point is that China’s debt burden is far higher than it likes to admit, and much of that debt has piled up in the past few years, as a result of Beijing’s response to the global financial crisis.
“Even though headline sovereign debt levels are low in China, so much quasi-sovereign activity happens through the banking system that if you include some of those contingent liabilities, the number can get very big,” says Charlene Chu, head of Fitch’s China Bank Ratings.
“People forget that China undertook its fiscal stimulus package through the banking system rather than by issuing public debt in the way that other countries did.”
While government debt in China is definitely much larger than it appears at first glance, nobody is predicting an imminent debt crisis.
“With an economy growing at a nominal rate of 15 percent, and tax revenues of around 26 percent of GDP, China clearly has more firepower than, say, Greece,” says Stephen Green, head of China research at Standard Chartered bank.
Another key point is that China, like Japan, does not have large external debts that could spark a crisis if they were called in.
In addition, China’s borrowing has mainly been used to fund infrastructure projects that will have future economic benefits for the country, whereas the U.S., for example, is borrowing huge amounts to pay for defense and social welfare programs that do not provide the same economic boost.
China’s fiscal picture is not quite as pristine as Beijing would have us believe, but surging growth rates cover up a lot of sins and the situation remains much worse in the west.
That is why the official Chinese media are having a field day after years of sanctimonious lecturing from western capitalists, and why they feel confident enough to declare that “all Americans, both Beltway politicians and those on Main Street, have to do some serious soul-searching to bring their country back from a potential financial abyss”.