Investing in China, or not, may be a hot topic if speculation about the size of China’s debt is true. The issue is one of hiding debt or reclassifying debt so that it shows up on a different balance sheet. Investing in debt and growth fits China as the nation has become an industrial powerhouse and borrowed along the way. China’s growth has attracted a lot of foreign investment. However, fundamental analysis of investment prospects is difficult when large amounts of debt are hidden from the public eye and that of the accountant.
It is not as though other nations are without sin in this matter of casting stones at debt. The United States’ total debt is calculated at nearly 95% of gross domestic product. The entire Group of 7 has debt to GDP percentages above 79%. China’s debt to GDP percentage is 22% according to Chinese government figures. The problem many see in China is its practice of taking government debt off the books. When the Asian currency crisis hit in the late 1990’s Indonesia, Korea, and Thailand were in trouble. China avoided the worst but still found that its banks had written a huge number of loans that became uncollectable when foreign investment faltered with the currency crisis. What China did was to create “management companies” for its four major banks. These companies took over the debt from non performing loans and issued bonds for these “assets.” The bonds were for ten years and the problem was swept under the rug. Picking new winners in China as the recession lifts will require a clear assessment of how much debt a company has and how strong its balance sheet is.
It is interesting that when ten years passed after the Asian currency crisis the four management companies all had different stories about residual debt but all of them went looking for “strategic partners.” Beware of investing in China with companies heading to the rescue of these debt management arms of Chinese banks. The passage of time will add other issues for investing in China. The country has had and enforced a one couple one child rule for decades. This policy has slowed growth in the world’s most populous nation to where India recently passed China as the nation with the most people. Fewer children has had the effect of aging China’s population. The traditional means of supporting the old in China is gone with its large families. Although the Chinese are big savers the government has no retirement programs and no health insurance programs for the elderly. Old age costs will come out of savings. The high savings rate in China will not come to the government’s rescue in a time of high national debt. It will go to caring for the elderly. Those interested in stock investing in China will need to look carefully at tax rates and social needs as they affect business growth in the nation. The Chinese government does not admit to any debt off the books but it is going to abandon loan guarantees for investment companies having local governments issue bonds instead, thus shifting debt responsibility to investors and away from government. Give thought to hidden debt when investing in China.