China’s rising leverage is a growing risk

Worries about the growth in China's leverage are on the rise. Is this growth in leverage sustainable? Alicia García-Herrero finds that the evidence is not so positive so far.

By: Date: May 12, 2017 Topic: Global Economics & Governance

This blog post was originally published on Nikkei Asian Review.


Worries over China’s rising leverage have been growing, especially since the country’s ratio of debt to gross domestic product surpassed 250% in 2016. This figure might appear reasonable when compared with developed countries, especially Japan and members of the European Union, but such a comparison only masks the different reality China faces.

fig 1 alicia

China’s GDP per capita is still much lower than that of developed economies, and a good part of its population, as well as many of its small and midsize enterprises, do not yet have full access to credit. Further financial deepening — an increase in the availability and range of financial services — will only increase private credit and, ultimately, leverage.

An easy way to understand where we could be heading in terms of China’s leverage is to note that the country’s total private credit — as proxied by bank credit and corporate bonds — already outweighs that of the EU. And yet China’s GDP per capita is less than one-third that of the EU. A simple extrapolation shows that once China reaches the EU’s level of per capita GDP, its leverage will have risen to $100 trillion, but this can only happen over several decades.

So, how sustainable is the growth in China’s leverage? While Chinese companies are generally not as leveraged as their international peers, at least in terms of liabilities to equity, a number of warning signals need to be taken into account.

First, by the same proxy measures, leverage is much lower for companies in the Association of Southeast Asian Nations. ASEAN companies may be similar to Chinese ones in that they also have more restricted access to deep financial markets than companies elsewhere in the world. However, Chinese companies have a shorter maturity on debt compared to global and even ASEAN peers.

Second, while Chinese companies seem to be less leveraged than their global peers in most sectors, one sector clearly stands out — real estate. Here, leverage is much higher for Chinese developers compared to the global average, and even to the average for ASEAN. This would not be a problem if the sector were small, but that is certainly not the case for China.

The real estate sector accounts for 21% of total Chinese assets, as opposed to an average of 5% for global peers, according to Natixis China Corporate Debt Monitor. The gap in the average maturity between assets in the Chinese real estate sector and in the rest of the world is larger than for other sectors.

SUSTAINED MOMENTUM? This brings us back to the key question: Is a massive increase in corporate leverage sustainable?

China’s wide fiscal elbow room and its financial isolation from the rest of the world due to massive capital controls mean the country can support an increase for some time. In the midterm, though, the answer basically depends on how profitable underlying investments will be. So far, the evidence is not very positive.

fig 2 alicia

First, the profitability of Chinese companies, in terms of return on assets, has fallen from above 4.5% in 2009 to less than 2% today, according to a report published by the International Monetary Fund last April, which also cited the persistent issue of overcapacity.

Additionally, Chinese companies’ foreign spending sprees especially in Asia — emerging Asia is the largest recipient of foreign direct investment from China — could be an opportunity to increase their return on investment. This has long been the case for Japan, which has obtained a higher return on outward FDI (about 7%, according to Natixis estimates) than on domestic investment (less than 3%).

However, Japanese outward FDI has been mainly of the greenfield type, which involves starting foreign businesses from scratch. China relies more on mergers and acquisitions abroad. It is hard to tell whether the recent purchases by Chinese companies will yield as high returns as Japanese outward FDI, but some of the most recent purchases could raise some eyebrows based on pricing or lack of obvious synergies with the buyer.

In sum, while China’s leverage is clearly high and likely to increase further — especially in the corporate sector — it could be justified if the returns on the underlying investments are high enough. The situation clearly differs between sectors but, overall, the return on assets is increasingly low in China and already well below most peers in emerging countries.

Outward FDI may help, but it would have to increase massively as its stock is small compared to China’s stock of domestic capital. Emerging Asia should thus expect the tide of Chinese FDI to continue, but from increasingly leveraged corporations, posing a clear risk of contagion in the future.

China’s recent M&A spree resembles the behavior of a shopaholic more than a strategic plan. It remains to be seen whether the downward trend in China’s return on assets will change and whether that will alleviate the burden of China’s leverage issue in the long run. Emerging Asia’s increasing dependence on Chinese companies is a new potential channel of contagion for policymakers to take into account.

Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to communication@bruegel.org.

View comments
Read article More on this topic More by this author


China real estate developers: a grey rhino in the jungle of financial risks

The author assesses the Chinese real estate industry’s liquidity concerns and its leverage, which is estimated to be four times higher than its global peers.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: September 18, 2018
Read about event

Past Event

Past Event

China's digital economy

How to measure China's digital economy?

Speakers: Alicia García-Herrero, Claudia Vernotti and Reinhilde Veugelers Topic: Global Economics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 17, 2018
Read about event More on this topic

Past Event

Past Event

Perils and potential: China-US-EU trade relations

We are hosting a number of Chinese and EU experts to discuss trade relations between the three forces.

Speakers: Miguel Ceballos Barón, Alicia García-Herrero, Wei Jianguo, André Sapir, Herman Van Rompuy, Zhang Weiwei, Guntram B. Wolff, Zhou Xiaochuan, Zhang Yansheng and Ruan Zongze Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 17, 2018
Read article More by this author


US-China trade war: What’s in it for Europe?

To help evaluate whether the market response is warranted or exaggerated, the author measured the trade impact of additional import tariffs based on standard economic theory, namely two key parameters—the tariff pass-through rate and the price elasticity of demand. The end of multilateralism seems clear, at least for trade.

By: Alicia García-Herrero Topic: European Macroeconomics & Governance, Global Economics & Governance Date: August 23, 2018
Read article


Goodbye deleveraging: Fiscal and monetary expansion to support growth in China

China has opted for a renewed fiscal and monetary stimulus to address the risk of the US-led trade war. The dual policies send a clear signal that economic growth is the priority, but such measures do not come without a cost. Deleveraging efforts will have to be put on hold for the time being.

By: Alicia García-Herrero, Gary Ng and Jianwei Xu Topic: Finance & Financial Regulation, Global Economics & Governance Date: August 23, 2018
Read article More on this topic More by this author


Can Multilateralism Adapt?

Global governance requires rules, because flexibility and goodwill alone cannot tackle the hardest shared problems. With multilateralism under attack, the narrow path ahead is to determine, on a case-by-case basis, the minimum requirements of effective collective action, and to forge agreement on reforms that fulfill these conditions.

By: Jean Pisani-Ferry Topic: Global Economics & Governance Date: July 3, 2018
Read article More on this topic More by this author

Blog Post

US tariffs and China's holding of Treasuries

China has the biggest bilateral trade surplus vis-à-vis the US but is also a top holder of US government bonds. While China has started to counteract US trade tariffs, economists have been discussing the case of China acting on its holdings of US Treasuries. We review recent contributions.

By: Silvia Merler Topic: Global Economics & Governance Date: July 2, 2018
Read about event More on this topic

Past Event

Past Event

Trade war trinity: analysis of global consequences

Analysis of the long-term impact of the trade war and its three key players: EU, US, and China.

Speakers: Alicia García-Herrero, Ignasi Guardans and Carl B Hamilton Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 28, 2018
Read article More on this topic

Blog Post

China’s strategic investments in Europe: The case of maritime ports

The EU is currently working on a new framework for screening foreign direct investments (FDI). Maritime ports represent the cornerstone of the EU trade infrastructure, as 70% of goods crossing European borders travel by sea. This blog post seeks to inform this debate by looking at recent Chinese involvement in EU ports.

By: Shivali Pandya and Simone Tagliapietra Topic: Global Economics & Governance Date: June 27, 2018
Read article More on this topic

Blog Post

The G7 is dead, long live the G7

The summit in Charlevoix left behind a Group of Seven in complete disarray. The authors think that the G-group, in its current formulation, no longer has a reason to exist, and it should be replaced with a more representative group of countries. In this fast-changing world, is the G7 only a relic of the past?

By: Jim O‘Neill and Alessio Terzi Topic: Global Economics & Governance Date: June 13, 2018
Read article Download PDF More on this topic

Working Paper

European and Chinese trade competition in third markets: the case of Latin America

While Europe continues to hold important trade powers, the rise of China in the global economy has significantly reshaped international trade and competition. In this paper, the authors show that the degree of competition between both powers in Latin America has risen in the past decade due to China's increased trade of high-quality products. They address whether China is an increasingly relevant competitor for Europe in Latin America and in which sectors China-EU competition is fiercer. These findings should be a wake-up call to Europe in its quest to remain competitive at the global level.

By: Alicia García-Herrero, Thibault Marbach and Jianwei Xu Topic: Global Economics & Governance Date: June 7, 2018
Read article More on this topic More by this author

Blog Post

China’s new role in the global economy

The changing role of China in the world economy has recently been highlighted by its registering of a first current account deficit in 17 years. We review the economists’ analyses of this new role and associated challenges.

By: Nicolas Moës Topic: Global Economics & Governance Date: May 28, 2018
Load more posts