China’s decision to re-leverage its economy is a major U-turn, and could have serious consequences

Reuters/Damir Sagolj

• China is re-leveraging its economy, with lending rebounding after years of restrictions. 
• Chinese companies are already snowed under large amounts of debt with these measures set to provide only a short term boost. 
• "While the re-leveraging will likely be positive for short-term growth and equity market, it may increase investor concerns about China’s medium-term objective of containing leverage and financial sector risks," said UBS analysts in a note. 

The mountain of debt encumbering China’s economy looks set to grow after private companies piled on leverage at the start of 2019. 

Having spent two years trying to de-leverage — reduce debt piles — in an attempt to rebalance its economy China appears to have changed its policy. Its a risky decision given the already staggering levels of leverage that exist in the Chinese economy. 

China’s overall leverage ratio stood at 243.7% at the end of 2018, with corporate debt reaching 154%, according to Zhang Xiaojing, deputy head of the Institute of Economics at the Chinese Academy of Social Sciences, cited by Bloomberg.

It appears this addiction to debt is hard to shake with China adding 4.6 trillion yuan ($687 billion) in new TSF, (total social financing) significantly higher than expected and 1.5 trillion yuan ($220 billion) more than one year ago.

The surge in January was particularly pronounced in short term corporate debt. New corporate loans reached 2.6 trillion yuan in January, though around 1.1 trillion yuan ($160 billion) were either short-term loans or bill financing, according to UBS. 

Read more: Global debt is not yet at financial crisis levels — but could be set for an explosion with China leading the way

Intriguingly, the start of 2019 has seen one of the major trends of Chinese investing rearing its head. Stock purchases through margin lending, or borrowing to buy, rose sharply with the total amount of outstanding loans up to 35.3 billion yuan this month ($5.26 billion).

This comes despite the fact that much of the Chinese market was closed for Lunar New Year celebrations in February suggesting that lending, and therefore leverage, is back on the agenda again this year.

It suggests that investors are buying the boom in stock prices that have come about on greater trade war optimism in recent weeks. Chinese stocks have bounced — with the Shanghai Composite having its best day since 2015 on Monday — despite having been the world’s worst performing market in 2018. 

Chinese companies have so far struggled to climb out from under vast piles of debt, despite a period of deleveraging, making the current moves to pile on greater amounts a risky decision for the country’s already slowing growth prospects.

"While the re-leveraging will likely be positive for short-term growth and equity markets, it may increase investor concerns about China’s medium-term objective of containing leverage and financial sector risks," said UBS analysts in a note. 

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Source: Business Insider – cburroughs@businessinsider.com (Callum Burroughs)