Evergrande is just the tip of China’s debt iceberg

China has a massive amount of corporate debt. At $27 trillion, it boasts a debt-to-GDP ratio of 159%, almost 60% higher than the global rate and nearly twice that of the US, according to research published this month by S&P Global Ratings.

“China’s growth has been largely driven by two contours: One is credit, and the other is carbon,” says Eunice Tan, one of the report’s lead authors and head of credit research for S&P Global Ratings’ Asia-Pacific region.

Beijing now wants to tame both those economic engines—credit and carbon—while maintaining stability and control, and while continuing to hit GDP growth targets. On the carbon front, it has released a high-level policy framework outlining a path to peaking carbon emissions by 2030. On the credit front, the central bank has sought to tame debt in the property sector and shield banks from exposure to troubled developers.

Which industries have the most debt?

While indebted Chinese real estate developer Evergrande has been in the limelight for all the wrong reasons lately, real estate is not the country’s only heavily indebted industry. Evergrande has so far managed to avert what would have been one of the largest defaults in history, but many other firms throughout China’s corporate landscape are saddled with debt.

In its report, S&P Global Ratings sampled over 25,000 firms, of which more than 5,700 were China-based. Examining the financials of those Chinese firms, they found that those in construction and engineering were the most heavily indebted, with 91% of firms exhibiting a high level of indebtedness. By S&P’s metrics, a firm is considered to exhibit a high level of indebtedness if its free cash flow is less than 12% of its total debt.

After construction and engineering, the second most indebted sector is transportation. Tan explained that the sector includes both transportation infrastructure and transportation providers. Regional government officials have long financed infrastructure investment to boost GDP growth using what’s called local government financing vehicles (LGFVs) that can hide debt off the books. Beijing is now stepping up restrictions on LGFVs.

Tan says that China’s substantial levels of corporate debt, far above global levels, highlight the risk of contagion should Evergrande’s collapse come to pass. “Clearly, it highlights credit strains simmering across some of the Chinese corporates.”

Still, significantly reining in China’s corporate debt levels would require a fundamental rejigging of the country’s economic model. For decades, debt growth has fueled economic growth, and the two have become so entangled that it’s difficult to lower debt without levels crimping growth. While Beijing is taking steps to reduce leverage, a key question remains, as posed by the title of the S&P report: Can China escape its corporate debt trap?

“[T]he leverage levels of China’s corporate sector are significantly above the global average,” the report noted. “It is a US$27 trillion problem that is increasingly getting the attention of Beijing.”

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