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China’s Addiction to Debt Now Threatens Its Growth - The New York Times




SHANGHAI — China has gone on a spending spree, borrowing money to build cities,
create manufacturing giants and nurture financial markets — money that has helped
drive the economic powerhouse in recent years. But the debt-fueled binge now
threatens to sap growth in the world’s second largest economy.

With its economy maturing, China has had to pile on ever more debt to keep
growth going briskly, a pace that could prove unsustainable. And the money is
increasingly flowing through opaque channels that operate outside the regulated
banking system, leaving China vulnerable should those hidden risks blow up.

A major credit rating agency sounded the alarm on Wednesday, saying the
steady buildup of debt would erode China’s financial strength in the years ahead. The
agency, Moody’s Investors Service, cut the country’s debt rating, its first downgrade
for the country since November 1989, five months after the Tiananmen Square

China’s debt problems are drawing comparisons to Japan’s predicament. After a

long, increasingly credit-backed boom, the bubble burst for Japan in the early 1990s.
Since then, the Japanese government’s reluctance to deal with deeply indebted
companies has contributed to decades of sluggish growth.

China’s addiction to debt traces back to the global financial crisis in 2008. As world

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China’s Addiction to Debt Now Threatens Its Growth - The New York Times

growth faltered, China unleashed a wave of spending to build highways, airports and
real estate developments — all of which kept the economic engine chugging.

To finance the construction, local governments and state-run companies

borrowed heavily. Even after the worst of the crisis passed, China continued to rely
on debt to fund growth.

But credit no longer packs the same punch for China. An aging work force,
smaller productivity gains and the sheer math of diminishing returns mean that
China has to borrow more money to achieve less growth.

The country’s debt has recently been increasing by an amount equal to about 15
percent of the country’s output each year, which has kept the economy expanding
between 6.5 percent and 7 percent. Debt, by the same measure, barely changed from
2001 to 2008, when the country achieved some of its fastest, double-digit growth

The borrowing binge of late has also been propelled by murky investments with
potentially big risks. Foresea Life Insurance, for example, offered souped-up policies
that looked more like high-octane investments than staid life insurance.

The products promised interest rates more than double traditional bank
accounts, attracting droves of ordinary investors. To churn out those gains, Foresea
took increasingly speculative bets, pouring the money into real estate, corporate
deals and China’s turbulent bond market.

China in recent months has stepped up a campaign to clean up the financial

system, which is riddled with such products.

Regulators banned Foresea from selling most new policies and barred its
chairman from the insurance industry. Another major insurer, Anbang, a politically
connected company that has made a series of controversial bids for large American
companies, was similarly blocked this month from offering two investment products.

For China, it is a matter of stability. At a meeting with top leaders last month,

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China’s Addiction to Debt Now Threatens Its Growth - The New York Times

“Finance is the core of a modern economy,” Mr. Xi said. “We must do a good job
in the financial sector in order to ensure stable and healthy economic development.”

Foresea has pointed to the potential for instability from its own mess. A memo
reportedly from Foresea, sent anonymously last week to several Chinese media
outlets and reviewed by The New York Times, warns of mass demonstrations,
presumably by policyholders, if it cannot raise more money and shore up its finances.

Chinese media said the memo appeared to be genuine — it carried the company’s
official seal and other identifying information. The company declined to comment,
issuing a statement last week saying that its cash flow was fine.

Chinese authorities are facing a complex, economic puzzle: how to squeeze debt-
fueled speculation out of the system without choking off growth or drawing unhappy
investors into the streets.

The government’s latest efforts to reduce risk have contributed to turbulence in

the country’s markets. Higher borrowing costs and unusual distortions in lending
suggest that investors are skittish about growth. After a strong start to the year,
China’s economy is showing signs of cooling.

Here lies Beijing’s challenge. The country is reluctant to take strong measures to
control overall credit growth, fearing a broad slowdown in lending could prevent the
economy from reaching the Chinese leadership’s growth targets. But without drastic
action, the debt levels will keep rising, in potentially unsustainable ways.

“China’s recent economic growth trajectory has been accompanied by a buildup

of imbalances and vulnerabilities that poses risks to its basic economic and financial
stability,” Andrew Fennell, the director of Asian sovereign debt ratings at Fitch
Ratings, said.

Foresea is an extreme example of the manic speculation that hangs over the
entire system.

The insurer collected just $40 million in premiums in its first year after it was

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China’s Addiction to Debt Now Threatens Its Growth - The New York Times

Insurers, trusts, non-bank financial companies, small local banks and other
semiregulated or unregulated businesses have all been trying to ride China’s ever-
expanding credit markets to quick profits. They have accounted for more than half
the country’s overall lending activity.

Foresea started to run into problems late last year. Its founder and controlling
shareholder, Yao Zhenhua, made a hostile bid for Vanke, one of the country’s largest
real estate buyers, with plans to fund the deal in large part with insurance premiums.

Those types of highly leveraged deals are getting more scrutiny. And Chinese
authorities have started to publicly warn about speculative, loosely regulated lending.

“The continuing increasing leverage rate is not good for sustainable development
of the economy, and some risks have accumulated,” Yi Gang, a senior deputy
governor of the central bank, said in March. “We should think first to stabilize
leverage — that is, to stabilize the overall rate of leverage, or let it grow more slowly.”

Zhou Xiaochuan, the governor of the central bank, said the same month: “Every
enterprise, especially those with too high a rate of leverage, should be controlled.”

Foresea was among the first to be pinched.

The China Insurance Regulatory Commission in December banned Foresea from

offering new products, contending that the company was essentially selling high-
yield debt even though it had permission to issue relatively low-risk life insurance.
Two months later, the regulator accused the company of misleading authorities.

“The fact that Foresea Life made up and provided fake material is clear,” the
commission said. “It is a serious circumstance that should be punished according to
the law.”

The moves have spooked customers. Revenues from newly issued policies
plummeted 99.8 percent in the first quarter from the same period last year, to just
$11.4 million. Investors also became wary, demanding their money back.

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China’s Addiction to Debt Now Threatens Its Growth - The New York Times

“Most of the clients are in economically developed areas like Guangdong,

Jiangsu, Shanghai,” the memo read. “Clients from these areas have a strong
awareness of protecting their rights. The possibility of mass disturbances cannot be
ruled out.”

Follow Keith Bradsher on Twitter @KeithBradsher

Ailin Tang contributed research.

A version of this article appears in print on May 25, 2017, on Page A1 of the New York edition with the
headline: Beijing’s Addiction to Debt Now Puts Its Growth at Risk.

© 2017 The New York Times Company

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