China and the US are worlds apart when it comes to debt, says Ashmore’s Dehn

Jan Dehn, head of Research at Ashmore, discusses why China and developed economies such as the United States, are worlds apart in terms of their debt profiles.

We review the latest debt numbers from China. We calculate the sustainability of China’s debt stock going forward and we compare the results with US debt dynamics. We show that China and the US are worlds apart when it comes to debt. We conclude that the market continues to significantly under-estimate risks in developed economies and overstate them in Emerging Markets.

China’s National Audit Office (NAO) has completed its root and branch review of Chinese government debt and published its findings. The NAO’s report shows that China’s total government debt was 56% of GDP as at mid-2013; local currency debt comprised 33% of GDP and central government debt 23% of GDP. By any standards these are moderate levels of debt, especially taking into account China’s high savings rate, high rates of real GDP growth, and strong asset position.

Much attention has been focused on the rapid rise in local government debt from 26.7% of GDP in 2010 to 33.2% of GDP in 2013. But the overall level of local government debt remains low both in absolute level terms and also in comparison with developed economies. Moreover, the Third Plenum recently introduced measures to control local government debt issuance, including:

• Measures to reduce local government spending
• Introducing more sources of tax and dividend income for local governments
• Increasing the role for bond markets
• Divesting activities to the private sector

The real significance of the low overall debt levels in China is that they are inconsistent with the commonly voiced thesis that China is financing over-investment with debt and therefore heading for collapse. The over-investment thesis derives mainly from a view that China consumes too little, but in fact China consumes a great deal more than official reported numbers suggest.

To put China’s debt trajectory into context we have also updated our debt sustainability model for the United States using IMF’s 2014 forecasts for the US fiscal position. We find that total US government debt is set to rise to more than 160% of GDP over the same period from just over 100% of GDP today. Fig. 2 shows the macroeconomic assumptions behind these projections. Note that we have used averages of the longest time series available as estimates of US growth rates and inflation rates going forward.

So how sensitive are the debt trajectories in the two countries to changes in the fiscal position, growth rates, and real interest rates? China’s debt situation is sound, sustainable, robust to rising interest rates, and can be improved dramatically with just a modest fiscal adjustment. The United States’ debt situation is weak, unsustainable, is vulnerable to even modest rate increases, and cannot be fixed with just a modest fiscal adjustment.

In conclusion, China’s latest debt numbers are reassuring. China’s debt is sustainable and seen within the context of the reforms recently announced in the Third Plenum, the outlook for China continues to look bright. China and developed economies such as the United States, are worlds apart in terms of their debt profiles. When looking at the hard data it is difficult to escape the conclusion that risks are still massively underestimated in developed economies, such as the United States, and significantly overstated in Emerging Markets, such as China.

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