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Beyond Ratings Weekly Digest

Your briefing on augmented financial risk analysis

N°138 ▪ 22nd March 2018


High levels of China’s debt: should we fear a financial crisis?

Are rising debt to GDP ratios around the world a sign that another financial crisis is looming? Would China be the place where the next financial collapse could occur? The country’s outstanding public sector debt, valued at about c. USD 4,000 billion, is dwarfed by the vast assets controlled by the various levels of governments. The answer to this question is probably no, at least not in the short term. Explanations are still needed and the trajectory of the Chinese debt is still not good news.

For decades, the debt to GDP ratio has been widely used as the key gauge of a county’s financial vulnerability. Nevertheless, this measure has proved to be misleading. In the mid-1990s, when Japan’s gross debt to GDP ratio approached 120%, many concluded that the country was heading for fiscal ruin, which would inevitably collapse the bond market and the yen, and cause hyperinflation. What has happened since then is that this same ratio has risen to more than 250% in 2017, while Japanese government bond yields have fallen to zero. Japan has suffered decades of price deflation.

Looking around the world, the levels of interest rates for different countries are negatively correlated with levels of total indebtedness. On the one hand, countries that have borrowed aggressively – such as Japan, China and Singapore – have very low or zero interest rates. On the other hand, countries that have barely borrowed, including Brazil, Russia and Indonesia, usually pay very high interest rates. This negative correlation is highly significant, disproving the widely held notion that higher debt levels lead to higher risk premia at the macroeconomic level. How is this negative correlation explained? Interest rates are the price of domestic savings, and countries with more abundant savings almost always have lower interest rates. Moreover, every economy needs to transform its domestic savings into investment, usually through the banking system. It is inevitable, therefore, that countries with higher savings rates have lower interest rates, but higher levels of credit creation (or debt to GDP ratios), because banks need to extend more credit to move larger pools of savings into investment. This means there is nothing wrong with high-saver countries having high debt to GDP ratios.

Breakdown of Chinese debt by entities (% GDP)

Sources: Beyond Ratings, IMF

The fundamental problem with this ratio is that it only provides a narrow snapshot of an economy’s debt picture. Debt is a stock concept, while GDP is a flow. The ratio tells you more about how much of an economy’s accumulated savings have been allocated via the debt channel. It does not tell us anything about a country’s net asset position. Nor does it provide any information on debt-servicing costs or the mix of local versus foreign currency-denominated debt. As such, the debt to GDP ratio gives us almost no information on a country’s ability to sustain its debt. IMF calls for China banks to boost capital buffers. In recent years, the rapid escalation of China’s credit to GDP ratio has been watched keenly by the investment community. Many predict that a debt crisis in the country would be the next big event that would bring down the world economy and global financial markets.

China’s domestic saving rate was 46% in 2016, which amounts to c. USD 6,000 billion of new savings each year. This vast pool of savings primarily relies on state-owned banks for allocation. It is therefore inevitable that the country has a high credit to GDP ratio. Furthermore, so-called credit risk in China is, in fact, sovereign risk. The Chinese government often relies on bank credit to finance government stimulus programmes. In 2009, Beijing launched a fiscal package worth more than USD 600 billion to combat the effects of the global recession that followed the global financial crisis. Subsequently, Chinese bank credit growth climbed steeply, lifting the credit to GDP ratio to new highs. In essence, the Chinese government was using credit expansion to finance fiscal stimulus. This was a credit-based equivalent of the Troubled Asset Relief Program in the United States. There, fiscal stimulus programmes are financed by increasing public sector debt. In China, they are often funded by depositors. China has a chronic current account surplus and has been a net creditor to the rest of the world for decades. Beijing’s outstanding public sector debt, valued at about $4tn, is dwarfed by the vast assets controlled by the various levels of governments. Therefore, China’s sovereign risk is extremely low. Importantly, the balance sheets of the Chinese state-owned banks, the government and the People’s Bank of China are all interconnected. Under these circumstances, a debt crisis in China is almost impossible in the short term.

Julien Moussavi, Head of Economic Research



Sovereign Risk

The twelve works of Putins

While Vladimir Vladimirovich Putin won the presidential election with 77% of votes on March 18 2018, for his fourth term in office (second consecutive), questions arise about the legacy of his economic policy. Indeed, if Russia has been out of recession since 2016, its economic model seems to be running out of steam, and the country could enter a period of very weak growth, far from the stratospheric growth rates recorded in the early 2000s. From 2003 to 2007, real GDP growth rate was around 7.5% on average, while potential growth was only 1.5% in 2017 according to the IMF. Until now, Putin answered this challenge with political action, such as the affirmation of Russian sovereignty internationally. However, a strong economic answer is needed in order to avoid an economic stagnation, which could undermine the government’s authority in the medium-term.

Selected Economic Data, Russia

Sources: OECD, IMF

For his next term in office, Putin would have to address many structural challenges of Russian economy. First of all, Russia has to diversify its economic activity. The country’s dependence to commodities provides strong volatility in economic performance as growth correlates with the price of oil, and creates a context that is not conducive to technical progress and the development of other sectors, as an appreciation of the exchange rate resulting from a large current account surplus related to raw material exports compresses the development of non-commodity-related economic sectors, handicapping their international competitiveness. Secondly, this diversification needs an increasing investment rate, which was only 22% in 2016 according to the IMF. This increase is a necessity in order to improve the potential growth. Finally, some institutional reforms could eventually boost private investments. Indeed, Word Governance Indicators, published yearly by the World Bank, highlight some concerns about Rule of Law, as an example.  As we have seen earlier, Putin’s economic challenges seem daunting. However, after three terms as president and a first term mandate, perhaps the desire to go down in history as the president who succeeded in getting the Russian economy back on track will prompt the president to initiate reforms required…

Sources: Beyond Ratings, OECD, IMF


One Last Flew Over the Cuckoo’s Nest?

European Common Bird Index / (11 Countries)

This indicator integrates the population abundance and the diversity of a selection of common bird species (167) associated with specific habitats (farmland (39), forest (34) and generalists (94)). It shows a rapid decrease of the avian biodiversity in Europe during the last 20 years with a drop of 32%. Several causes explain this decline such as pollution, intensive use of insecticide that limits food access, human destruction of their habitats (forests, wetlands…)  for single-crop farming or urbanization purposes.

Unfortunately for birds, Climate Change is approaching and this threat is arriving faster than their adaptation ability. This will lead to a mismatch between the breeding period and food abundance, arrival of a new kind of predators more adapted to warmer climates, loss of habitats (sea risen, forests change…), deadly heat periods, disease spreading… Even for cuckoos, the situation is complicated. Indeed, due to higher spring temperatures, hosts’ breed period is earlier than the long-distance migratory Common Cuckoo arrival.  Nests are not hospitable anymore. Times are tough, even for parasites!

Sources: Beyond Ratings, Eurostat

Carbon/Climate Change

How many jobs in renewables?

Renewable energy employment in selected countries in 2016 (thousands)

When including large hydropower, the renewable energy sector employed 9.8 million people in 2016 (directly and indirectly). Most of these jobs were (by far) in China. In fact, China had about 4 times as many jobs as Brazil, the second country with the highest number of jobs. In addition, it is estimated that 50% of China’s jobs in renewables are in solar power with about 2,0 million jobs, and the number of China’s solar photovoltaic jobs is 6,5 times higher than in the country that comes in second position (Japan). It can also be noted that the share of Asian countries has significantly increased in recent years, from 50% of renewables jobs in 2013 to 62% in 2016 (excluding large hydropower), along the development of Asian equipment manufacturing activities. This is not just about China whose share increased (only) from 41% to 44% on this period. Although the race for leadership is not finished, these are figures to be kept in mind.

Sources: Beyond Ratings, IRENA


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