China’s risky dollar debt addiction

China’s foreign debt has been rising rapidly, and that’s becoming an increasingly big problem — for the country and, potentially, the world.
Officially, China lists its outstanding external debt at $1.9 trillion. For a $13 trillion economy, that’s not a major amount. But focusing on the headline number significantly understates the underlying risks.
Short-term debt accounted for 62 percent of the total as of September, according to official data, meaning that $1.2 trillion will have to be rolled over this year. Just as worrying is the speed of increase: Total external debt has increased 14 percent in the past year and 35 percent since the beginning of 2017.
External debt is no longer a trivial slice of China’s foreign-exchange reserves, which stood at just over $3 trillion at the end of November, little changed from two years earlier. Short-term foreign debt increased to 39 percent of reserves in September, from 26 percent in March 2016.
The true picture may be more precarious. China’s external debt was estimated at between $3 trillion and $3.5 trillion by Daiwa Capital Markets in an August report. In other words, total foreign liabilities could be understated by as much as $1.5 trillion after accounting for borrowing in financial centers such as Hong Kong, New York and the Caribbean islands that isn’t included in the official tally.
Circumstances aren’t moving in China’s favour. The nation’s companies rushed to borrow in dollars when there was a 3 percent to 5 percent spread between Chinese and US interest rates and the yuan was expected to strengthen. Borrowing offshore was cheaper and offered the additional bonus of likely currency gains. Now, the spread in official short-term yields has shrunk to near zero and the yuan has been depreciating for most of the past year. Refinancing debt in dollars has become harder, and more risky.
Beijing’s policies have exacerbated the buildup of foreign debt. To promote Xi Jinping’s Belt and Road Initiative, the president’s landmark foreign policy endeavour, China has been borrowing dollars on international markets and lending around the world for everything from Kenyan railways to Pakistani business parks.
With this year and 2020 being the peak years for repayments, China faces dollar funding pressure. To repay their dollar debts, Chinese firms will either have to draw from the central bank’s foreign-exchange reserves or buy dollars on international markets. This creates a new set of problems. There are only 617 billion yuan of offshore renminbi deposits in Hong Kong available to buy dollars. If China was to push firms to bring debt back onshore, this would necessitate significant outflows that would push down the yuan’s value against the dollar.
International dollar investors need to be wary of Chinese-linked investments. China and the world need to think clearly about this growing dollar debt dependence. Any cessation of funding could have severe and unforeseen consequences.

—Bloomberg

Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News