An obscure new department heralds a shift in China’s debt cycle

China’s Ministry of Finance recently established a new debt management department, unifying the management of government debt quotas, issuance and redemption. What appears to be a simple adjustment reflects a profound shift in China’s economic governance. To counter the impact of the 2008 subprime mortgage crisis, China launched a 4 trillion yuan (US$563 billion) stimulus plan, shifting its growth model from exports to investment. From 2009 to 2014, growth was mainly driven by infrastructure investment and related manufacturing investments, from 2015 to 2019, by real estate and government public investments, and from 2020 onwards, by hi-tech and new energy manufacturing investments. Corresponding to these three phases of investment, China’s economy has experienced fluctuations every five to six years. Gross domestic product (GDP) growth has tended to align with the typical Juglar cycle – a fixed investment cycle of seven to 11 years – or equipment renewal investment cycle fluctuations. Debt cycles have mirrored these investment cycles: local government leveraging from 2009 to 2014, household leveraging from 2015 to 2019 and central government leveraging since 2020. Between 2009 and 2017, manufacturing enterprises, urban investment companies – special purpose state-owned enterprises responsible for financing local investments – and real estate firms also leveraged off each other. China’s debt expansion created a large number of tangible state-owned assets, such as roads, bridges, factories, buildings and industrial estates. These state-owned assets are closely tied to urban land, which is entirely owned by the government. As a result, land has become the core collateral in China’s investment and debt cycles during the past decade or more. Some land is leased cheaply to industrial businesses to address employment and taxation. Some land use rights are sold at high prices to real estate firms to generate substantial land transfer fees, which are a major fiscal revenue source for local governments to fund investments and repay debts. Some land is injected into urban investment companies and used as collateral to secure financing, including loans and bonds. At the household level, people realise the government relies on land sales for revenue, so they expect land and housing prices to continue to rise, making them willing to take on debt to buy homes. Real estate firms serve as the intermediary in this economic loop, realising land value in the market and driving investment in steel, cement, appliances, automobiles and other industrial sectors. This “land-infrastructure-debt” triangular cycle outlines the framework of China’s economic loop from 2009 to 2019. In fact, the 2008 US subprime mortgage crisis brought greater changes to China than other economies, serving as a catalyst of China’s debt cycle. Things began to change after 2020, when China’s central government started to tackle systemic debt risk. Policies vary, but the key is to restrict the ability to access new financing. Debt, especially when it grows to a certain scale, requires continuous rollover through new borrowing to repay old debts. Thus, policies restricting new financing have had a significant impact, shifting these two major debt engines – real estate and urban investment firms – into low gear. In the past two years, China’s household leverage growth has stalled and corporate leverage growth has begun to lag behind government leverage growth. These changes indicate that China’s debt cycle is entering a new phase. It is in this context that the Ministry of Finance has established the new debt management department. The market appears to believe that since land assets as collateral for the debt cycle have been maximised and are now declining sharply, a key function of the new department is to enhance strict oversight of debt, particularly controlling new local government-led debt. But from numerous micro-level clues and facts, it is evident that China’s debt expansion has diverted rather than stalled. Simply put, it has shifted from a land-collateral-driven debt cycle to one driven by science and innovation collateral. For example, many urban investment companies own industrial buildings that are difficult to operate or rent out. Previously, these inefficient state-owned assets might have been sold at a low price, but now local governments are introducing tech firms to occupy these buildings, transforming the industrial buildings into tech towers. These tech towers are then used as collateral to secure new bank loans or financing. This is an example of conversion from land collateral to science and innovation collateral, allowing these leveraged funds to repay existing debts or reinvest in nurturing tech firms or tech-related projects. It explains why, despite severe fiscal strain, local governments remain eager to invest in hi-tech manufacturing and why hi-tech investment continues to grow by around 10 per cent annually, even as GDP growth moderates. As a result, the role of the debt management department could be more profound than it appears. It will certainly impose strict regulation on local debt related to traditional infrastructure projects, but it will also more systematically guide the transfer of the overall economy’s core collateral tools from land to new technologies, energy and industries. Valuing scientific innovation is more challenging than valuing immovable property such as land. Compared with the singular state-owned management system and homogeneous nature of land factors, however, science and innovation factors are more diverse, decentralised, flexible and friendly to private enterprises. At the same time, it might still be too early to definitively judge China’s new debt cycle. As economist Nassim Nicholas Taleb wrote in his book Antifragile, “Wind extinguishes a candle and energises fire.”

An obscure new department heralds a shift in China’s debt cycle

.css-1c6uqr6{color:inherit;font-weight:inherit;font-size:inherit;font-family:inherit;line-height:inherit;overflow-wrap:break-word;}In addition to regulating local government debt, the department will guide the nation away from a cycle driven by land as collateral

In addition to regulating local government debt, the department will guide the nation away from a cycle driven by land as collateral