Household Debt in China: A Misunderstood and Underestimated Risk Factor?

We have dedicated an article to explaining what the three main types of debt are when it comes to China, an article to the elephant in the room which is the corporate debt dimension and another article to public debt, which is a boogeyman for countries such as Japan (with its public debt to GDP ratio of well over 200%) but less so for China… what about household debt?

According to the People’s Bank of China, household debt as a percentage of China’s GDP now sits north of 60%, a level lower than that found in the United States but higher than in the European Union. Some international organizations have come with household debt to GDP estimates for China which are slightly lower and all in all, it is easy to paint the picture of a situation that isn’t necessarily amazingly positive but which doesn’t represent a monstrous threat either.

Would such a picture be accurate?

In our opinion, no.

The ChinaFund.com team, while remarkably bullish with respect to China’s long-term potential, strongly believes in putting rational as opposed to emotional analysis on the table and when it comes to this topic, we will do just that and start enumerating reasons why we believe the household debt situation is more attention-worthy than meets the eye:

1. The trend is your friend and the fact that household debt has more than doubled since 2012 represents a major cause for concern. Again, not necessarily the current household debt to GDP value but rather the growth rate it has been experiencing over the past eight years is troublesome in our view
2. The nature of the household debt growth, with mortgages being in the spotlight as the #1 debt type and many of them being speculative in nature. Of every 10 Chinese citizens who end up going after a mortgage, 7 of them already own a home and as such, their endeavor can be considered speculative rather than consumption driven. We have analyzed China’s fascination with real estate through a dedicated article, one which can be accessed by clicking HERE, we would strongly recommend reading it alongside this article for proper context
3. The sub-par financial literacy of the average Chinese borrower, an argument which is actually strengthened by the previous one and together, they paint the picture of a situation in which less than ideally financially educated Chinese citizens engage in debt-fueled real estate speculation… let’s just say it wouldn’t be the least bit difficult to imagine how this could end rather poorly
4. The fact that China is not what one would call a fully developed country from an economic perspective, certainly not to the degree suggested by its high nominal GDP, with China’s low GDP per capita figures making it clear that we also need to compare it to the less developed world (with China’s household debt to GDP ratio being higher than that of many not-quite-developed nations). As such, just because Western nations can get away with higher household debt to GDP levels, for example the United States, it doesn’t mean the market will grant China that exact same luxury… at least not for the time being, while it is still perceived as anything but a risk-off jurisdiction
5. The solvency issue or, in other words, the fact that household debt is pretty much at parity with household income in China. This, correlated with #3 (the less than optimal financial education level of the average Chinese citizen) makes it clear that default concerns should not be taken lightly, even if we haven’t had “blockbuster” examples such as the corporate debt-related ones which have been in the spotlight
6. The fragmented nature of China from an economic perspective. While someone from Beijing and Shanghai can handle a level of indebtedness closer to that found in Western countries, the same cannot be said about those who live in poorer regions. The PBOC has made it clear that low-income households need to be put under the proverbial microscope due to the systemic risk associated with let’s call it Chinese subprime debt (a term which should give those familiar with the Great Recession goosebumps)
7. The endogenous context, primarily the fact that this household debt trend is unfolding in a period when China’s double-digit growth years are long gone, while endogenous risks have been surfacing, anything from China’s overly-indebted corporate sector to the Coronavirus situation and its debilitating economic effects
8. Finally, the exogenous context that has been mentioned in other articles as well, primarily the fact that the international community (especially the West) is less willing to accept staggering trade deficits with China than in the past, with a textbook example to that affect being represented by… of course, the United States

To put it differently, the household debt equation is far more complex than meets the eye and needs to be viewed as a piece of a puzzle rather than simply something not problematic enough to represent a stand-alone issue. Many experts make the mistake of only taking look at some let’s call them headline statistics, comparing the situation to what we have in other countries and concluding that household debt concerns are unwarranted.

We believe such attitudes are dangerous, to the point of irresponsible.

Instead, we would highly recommend keeping a very close eye on household debt-related developments in China and including them in what needs to be a complex analysis based on a sound understanding of “all things China” because in the absence of a thorough research process, maximizing results in this jurisdiction becomes unlikely. Of course, should you be interested in delegating this process to an entity which knows what it is doing and that has been around the proverbial block in China for over a decade, the ChinaFund.com team is only an email/message away and will happily work with you and/or your organization so as to put together a coherent, hands-on decision-making framework.