“Too much, too soon?”

The key chart

Summary

The PBOC published its annual Financial Stability Review (2019) this week in which it highlighted the risks associated with the rapid accumulation of household (HH) debt in China. It noted that, “the debt risks of the household sector and some low-income households in some regions are relatively prominent and should be paid attention to.” (Financial Times, 2019). This supports my recent analysis of debt sustainability in Asia, in which I concluded that “relatively high excess HH growth rates in India and China remain a key focus point.“

I understand* that the PBOC’s analysis considers the period up to the end of 2018. In this post, I analyse how these risks have developed over the first three quarters of 2019 and conclude that they remain considerable. China’s HH debt ratio has risen further during 2019, with HH credit growing 9ppt faster than GDP on a three year CAGR basis. The rate of “excess credit growth” has moderated very slightly, but is still of concern given that China’s HH debt ratio (56%) is now close to the average HH debt ratio (60%) for all BIS reporting countries.

My analysis highlights two key points: (1) the level of debt needs to be considered in relation to its rate of growth (and its affordability and structure); and (2) even, in the most benign outcome, China’s increasing HH debt burden represents a key headwind for economic growth and the transition to a consumption-driven economy.

(* n.b. I have been unable to find an English version of the 2019 FSR, so my comments on its content here are based on secondary sources)

A review of last month’s analysis

Last month I concluded that:

“In summary, the risk associated with excess credit growth across EM are lower than in previous cycles. Asia stands out, however, because the highest rates of growth have occurred in economies that already have high debt ratios. In China and Hong Kong, these risks are compounded by high debt service ratios indicating rising “affordability” risks. RGFs in both economies are adjusting sharply lower in response. Risks in intermediate and emerging Asian economies appear lower, but the relatively high excess HH growth rates in India and China remain a key focus point.“

2019 update (as at end 3Q19)

HH credit has continued to grow strongly YTD. The average monthly YoY growth rate was 17% in nominal terms over the first nine months of 2019. This compares with an average of 19% for the full year 2018. HH credit growth continues to exceed nominal GDP growth – by 8ppt in 3Q19. As highlighted above, this is despite the fact that China’s HH debt ratio of 56% (3Q19 estimate) is closing rapidly on the average HH debt ratio for all BIS reporting economies.

Experience suggests that the key risk here is less to do with the level of debt and more to do with its rate of growth. In “Sustainable debt dynamics“, I introduced the simple concept of relative growth factor (RGF) analysis that I have used since the 1990s as a first step in analysing the sustainability of debt dynamics. In short, this approach compares the rate of “excess credit growth” with the level of debt penetration in a given economy. Red flags are raised when excess credit growth continues in economies that exhibit relatively high levels of leverage.

The trend in China’s HH RGF is illustrated in the chart above (rolling 3Y basis). The rate of excess HH credit growth has slowed in relation to recent history but remains unsustainably high in absolute terms, in my experience. At the recent peak, HH credit was growing 11ppt faster than nominal GDP (4Q17), hence the steep gradient in the earlier chart illustrating the HH debt ratio. As at the end of 3Q19, my estimates suggest that this excess growth rate has slowed to 9%.

Conclusion

As a macro and monetary economist, I start by analysing the level of debt in absolute terms and in the context of its rate of growth, affordability and structure. In my experience, this is the most important feature of the LT secular investment outlook with direct implications for: economic growth; the supply and demand for credit; money, credit and business cycles; policy options investment risks and asset allocation.

The risks associated with excess HH credit growth in China remain elevated and this analysis presents a relatively extreme example of the importance of considering the level of debt together with its rate of growth. History suggests that current trends in China are unsustainable. The most benign outcome is that the rate of growth in HH borrowing slows more rapidly with negative implications for consumption and aggregate demand. In short, China’s increasing HH debt burden represents a key headwind in the transition to a consumption-driven economy.

Please note that the summary comments above are abstracts from more detailed analysis that is available separately