by Viraj Shah
China is grappling with mounting debt. The countries credit to GDP ratio is at 28.8 percent. The U.S. economy was not able to ward off a financial crisis with credit to GDP ratio of 12.4 percent in 2008. Goldman Sachs‘ Sharmin Mossavar-Rahmani wondered how China will avoid the financial crisis which looms. China’s economy is one of the fastest growing among Asian countries. However, fears of slowdown and higher debt in company’s books have raised multiple questions among analysts.
So what has led to huge debt?
A higher investment in infrastructure and infusion of money is one of the primary reasons for mounting debt. Over a period of time the supply increased while the demand remained constant making many assets unutilized. The country is grappling with fears of slowdown while trying to ensure that companies don’t go bust.
Last month the government bailed out Sinosteel in a $9 billion debt for equity deal. As part of the deal, state owned banks agreed to accept shares of the later for repaying half of the debt. The government has set a bad example and such bailouts may happen more frequently in future, according to analysts.
Rising fraud in corporate debt market is another cause of concern. The size of debt market is worth $3 trillion and it is becoming increasingly difficult for companies to raise fresh money through new notes. As the pressure is mounts for repayment of debt, many scams are popping out.
An E&Y survey found that misreporting of financial numbers and fraudulent behavior as justifiable behavior for a company to survive in a downturn. CEO’s of 56 percent Chinese executives had participated in the survey.
Source: EY Global Fraud Survey, Page No: 39
Avoiding job losses
The government continued to infuse money in order to ensure that the economy grows. The ramification of increased supply from Steel, aluminum, and other industries is felt by America and Europe. Low cost Chinese exports have led to job losses in both the countries.
Cooling of property market
In an unprecedented move, the PBOC raised interest rates in an effort to manage financial risk. The central bank is making all efforts to make sure that the funds are illegally routed into real estate or stock markets. Analysts at UBS expect China’s GDP to Debt ratio to rise to as high as 300 percent over next two years.
The Chinese government is expected to have tough time. Taming debt and ensuring that there are no major bailouts should be the top most priority of the government.
by Viraj Shah