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Qualifier one. China has lots of bank debt, but the total liability position is not excessively high. Most of the concern around the level of Chinese debt comes from the fact that conventional bank loans are already higher as a proportion of GDP in China than in wealthy countries. This observation ignores the fact that this form of liability is a relatively small share of total liabilities in the developed world, but it is the dominant form of liability in China. Total financial liabilities (defined as conventional loans, equities, bonds [issued by government, financial and non-financial firms] and securitised loans) are approximately four and a half times GDP in the USA and Japan. In China the number is still below three. Our interpretation here is that the way forward is not to reduce the amount of liabilities in the system. It is to change the composition of those liabilities to better match the assets on the other side of the balance sheet. This would involve refinancing and paying down existing debt with other forms of financing that match the asset being funded; and encouraging new fund raisings to match the associated asset from the start.

Qualifier two. The debt load is concentrated on state-owned enterprises (SOEs) and local governments (LGs). This qualifier leads to the following conclusion: the most leveraged asset in China is an implicit central government guarantee. Would-be reformers of the SOE sector would like to see the central government formally deny that any such guarantee exists, thereby helping to level the playing field for private firms. Where LGs are concerned, wholesale fiscal reforms are required to address the structural imbalance in their budgetary positions. Given their dominance in the debtor field, SOEs and local governments will have to lead the way with regard to restructuring the liability stock. To do so, each sector could look to pay down debt with the proceeds of equity raising (SOEs) and infrastructure privatisation (LGs).

Qualifier three. Household and private corporate balance sheets are relatively healthy. Chinese households have barely begun to access credit like western consumers. Mortgage debt levels are still extremely low. High minimum down payments for housing purchases and two decades of price appreciation mean households enjoy large positive equity positions on their real estate holdings; and non-mortgage consumer credit is still an immature industry. In the corporate sector, according to IMF data private firms have cut their leverage ratios in half since 2007.

Qualifier four. The rest of the world owes China a lot of money. China is a huge international creditor courtesy of an unbroken string of current account surpluses this century. At the end of 2015 it held gross international assets of more than US$6 trillion set against around US$4.5 trillion in international liabilities. Notwithstanding the decline in foreign reserves in recent times, the majority of the asset position is comprised of negotiable debt claims on foreigners that could potentially be sold, and the proceeds repatriated, at any time. By contrast, the majority of foreign claims on China are direct investments: factories, buildings, strategic equity stakes etc, which are illiquid. These facts argue that China is not susceptible to the same forces that have precipitated financial crises in emerging markets time and again. Indeed, it is remarkably well self-insured against such an outcome.

It is also worthy of note that the biggest potential qualifier of them all – the ability of the Chinese central government to use its own balance sheet to assume a large part of the debt of the LGs and SOEs in one fell swoop - is not a zero probability. This would place the debt servicing burden on the balance sheet most equipped to bear it, due to both current financial resources and its control over the taxation system.

How do we use these qualifiers to form a view on end-use demand for our portfolio of commodities? First of all, our knowledge of the macro-financial sphere in China informs our understanding of the possible risks to growth in the economy as a whole, and in the sectors of most direct importance to us. This knowledge allows us to form concrete views on how the economy might develop under stress during a future global shock; to filter the noise in the public domain; and to assess the veracity of consensus positions on matters of importance indirectly linked to the China story.    

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