Chinas national balance sheet (2015) leverage adjustment and risk management

We have paid particular attention to theissues concerning the adjustment of the leverage ratio and the correspondingfinancial risk management and provided the policy recommendations on ho

China’s National

Balance Sheet (2015): Leverage Adjustment and Risk Management

Yang Li

Xiaojing Zhang

Xin Chang

China ’s National Balance Sheet (2015): Leverage Adjustment and Risk Management

Yang Li Xiaojing Zhang

National Finance and Development

Jointly published with China Social Sciences Press, Beijing, China

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Translated by Fu Yili

Part I General Report

1 Main Report: Leverage and Risk Management 3

1.1 Major Findings 4

1.1.1 National Balance Sheet 4

1.1.2 Sovereign Balance Sheet 5

1.1.3 Balance Sheets of All Sectors 6

1.2 Leverage Adjustment and Risk Management 11

1.2.1 Description of the Aggregation Method 11

1.2.2 Whole Society Leverage Ratio 12

1.2.3 Leverage Cycle 13

1.2.4 Dilemma Between Deleveraging and Ensuring Steady Growth: Molecular Countermeasure and Denominator Countermeasure 15

1.2.5 Leverage Adjustment and Financial Risk Management 16

1.2.6 The Fundamental Way Out Is to Change the Mode of Economic Development Through Reform 19

2 National Balance Sheet 21

3 Sovereign Balance Sheet 31

4 Whole Society Leverage Ratio 35

4.1 Leverage Ratio of All Sectors 35

4.2 Leverage Ratio of the Whole Society 42

Part II Sectoral Analysis 5 Local Government Balance Sheet 47

5.1 Preparation of Local Government Balance Sheet 47

5.1.1 Estimation of asset items 49

v

5.1.2 Estimation of liability items 525.1.3 Some additional explanations on estimation of local

assets and liabilities 565.2 Analysis and Assessment of Local Government Debt Risk 595.2.1 First, the Debt Growth Rate Is Still High 605.2.2 Second, the Financing Structure Tends to be More

Complicated 615.2.3 Third, the Liquidity Risk Due to Debt Maturity in a

Concentrated Time Period Should Not Be Ignored 615.2.4 Fourth, Regional and Sectoral Risks Should Arouse

Our Attention 635.2.5 Fifth, the Existing Debt Repayment Base Is

Somewhat Unsustainable 645.2.6 Sixth, the Risk Exposure to Contingent Liabilities

Is Widening 665.3 Discussion on Some Issues Concerning Local Debts 675.3.1 First, Establishing and Promoting a New Local

Financing Framework and PPP Model 675.3.2 Second, Local Debt Swap and Its Impact 715.3.3 Third, Further Improving the Degree of Marketization

of Local Debt 74

6 Analysis of Central Government Balance Sheet 776.1 The Balance Sheet of the Chinese Government Prepared

by the PBC 776.2 General Central Government Balance Sheet 796.3 The Central Government Balance Sheet as Part

of the National Balance Sheet 84

7 Balance Sheet of the Non-financial Corporation Sector 877.1 Introduction 877.2 Basic Principles for Indirect Estimation of the Balance Sheet

of Non-financial Corporations 907.3 Indirect Estimation of Total Assets and Liabilities

of Non-financial Corporations in China 927.4 Analysis of the Balance Sheet of Non-financial Corporations

in China and International Comparison 967.5 Conclusions and Policy Recommendations 100

8 Balance Sheet of the Household Sector 103

8.1 Updating Explanation 103

8.2 Balance Sheet of Households in China for 2004–2014 104

8.3 Analysis of the Balance Sheet of Households in China for 2012 104

9 Financial Sector Balance Sheet 109

9.1 Brief Introduction to the Statistical System for China’s Current Financial Sector Balance Sheet 109

9.2 Preparation of Balance Sheet of the Financial Sector 116

9.2.1 Converting the Sources & Uses of Credit Funds of Financial Institutions in RMB into the Form of Balance Sheet of Financial Institutions 116

9.2.2 Simplifying the Balance Sheet of Insurance Companies and Securities Companies 118

9.2.3 Consolidating the Simplified Balance Sheet of Insurance Companies and the Simplified Balance Sheet of Securities Companies into the Balance Sheet of Financial Institutions 124

9.2.4 China’s financial restructuring and growth mode changes 126

9.3 Conclusion 134

10 The Central Bank Balance Sheet 135

10.1 The Basic Elements of the Central Bank Balance Sheet 135

10.2 Changes in Total Assets and Liabilities of China’s Central Bank 136

10.3 Changes in the Central Bank’s Asset-Liability Structure 139

10.3.1 Foreign Assets 139

10.3.2 Claims on Government 143

10.3.3 Claims on Depositary Financial Institutions 145

10.3.4 Claims on Other Financial Corporations 148

10.4 Changes in the Liability Structure of the Central Bank 149

10.4.1 Reserve Money 149

10.4.2 Central Bank Bonds 153

10.4.3 Government Deposits 155

10.5 Changes in Net Claims of the Central Bank 157

11 External Sector Balance Sheet 161

11.1 Main Characteristics of China’s External Sector Balance Sheet 163

11.1.1 Asset Structure 163

11.1.2 Liability Structure 167

11.2 International Comparison 170

11.2.1 Comparison of Total External Assets and Liabilities 170

11.2.2 Structure Comparison 171

11.2.3 Comparison of Investment Returns on External Assets 176

11.3 Potential Risks of the External Sector and Their Prevention 179

11.3.1 Maturity Mismatch Risk 179

11.3.2 Currency Mismatch Risk 181

11.3.3 Capital Structure Mismatch Risk 182

12 Implicit Pension Debts and Reform of the Old-Age Insurance System 183

12.1 Pension Funding Gap and Implicit Debt—Changes and Causes 183

12.1.1 Changes in Incomes and Expenditures of the Old-Age Insurance in Recent Years and Comparison with the Previous Estimates 183

12.1.2 Pension Funding Gap After Updating the Data and Implicit Debt Estimates 187

12.2 Discussions and Suggestions on the Reform of the Old-Age Insurance 192

12.2.1 The Reforms Aiming to Reduce the Pension Funding Gap and Implicit Debt Reform Are Faced with More Resistance and We Should Avoid“Benefits Catching up and Surpassing” of the Old-Age Insurance System 193

12.2.2 Endowment Insurance for Urban and Rural Residents and Re-Discussion of Endowment Insurance Reform in Government Institutions 195

12.2.3 Postponement of Statutory Retirement Age and Investment of Pension Fund into the Stock Market 199

12.2.4 Inter-regional Co-ordination of Old-Age Insurance 201

13 Creating the Chinese Version of“Municipal Bonds” 205

13.1 Contrast and Thinking Behind the Numbers 205

13.2 “Soft Constraints” and “Hard Constraints” 207

13.3 Restoring the Original True Nature of “Urban Construction Investment Bonds” 208

13.4 Regulation Over Municipal Bonds: Standards and Classification 210

13.5 From a Class of Products to a Market 21213.6 Swap of Local Government Debts: Administrative

or Market-Oriented 21513.7 Fiscal and Tax Reforms: The Gap Between Reality

and Target 217Appendix A: An Explanation on the Main Preparation Methods

of This Book 219References 237Postscript 241

Fig 1.1 Various stages of a leverage cycle 14

Fig 2.1 Size of total national assets: 2007–2013 24

Fig 2.2 Size of total national liabilities: 2007–2013 24

Fig 2.3 Size of net national assets: 2007–2013 25

Fig 2.4 Size of national non-financial assets: 2007–2013 25

Fig 2.5 Size of national financial assets: 2007–2013 26

Fig 2.6 Size of net national financial assets: 2007–2013 26

Fig 2.7 Structure of total national assets in 2013 27

Fig 2.8 Structure of net national non-financial assets in 2013 27

Fig 2.9 Structure of national financial assets in 2013 27

Fig 2.10 Structure of total national liabilities in 2013 28

Fig 2.11 Structure of net national assets in 2013 28

Fig 2.12 Structure of net nationalfinancial assets in 2013 28

Fig 2.13 Changes in China’s debt to assets ratio: 2007–2013 29

Fig 3.1 Size and structure of China’s sovereign assets 33

Fig 3.2 Size and structure of China’s sovereign debts 33

Fig 3.3 China’s sovereign assets/liabilities and the government’s net worth 34

Fig 4.1 Changes in the leverage ratio of the household sector: 1996–2014 36

Fig 4.2 Changes in the leverage ratio of the non-financial corporate sector: 1996–2014 37

Fig 4.3 International comparison of non-financial corporate debt to total debt ratios 39

Fig 4.4 Changes in leverage ratio of the government sector: 1996–2014 40

Fig 4.5 Changes in the leverage ratio offinancial institutions: 1996–2014 41

Fig 4.6 Changes in the leverage ratio of the whole society: 1996–2014 42

xi

Fig 4.7 Changes in the leverage ratio of the whole society based

on MGI’s method: 1996–2014 43

Fig 5.1 Structure of total assets of local governments 56

Fig 5.2 Structure of total liabilities of local governments 56

Fig 6.1 Asset structure of the narrow central government balance sheet 83

Fig 6.2 Proportion of major assets in the general central government balance sheet 83

Fig 7.1 China’s economic growth rate (right axis) and debt to assets ratio (left axis) of various types of enterprises (left axis) 97

Fig 7.2 Ratio of assets of state-owned enterprises and industrial enterprises the total assets of non-financial corporations in China 98

Fig 7.3 Debt to assets ratio of non-financial corporations in major countries 99

Fig 7.4 Debt to GDP ratio of non-financial corporations in major countries 100

Fig 8.1 Changes in the housing value of urban residents: 1998–2013 107

Fig 9.1 Ratio of assets of the financial sector to GDP (The assets of the US financial sector come from the item of total assets offinancial corporations in the financial sector balance sheet, the assets of the Chinesefinancial sector are calculated by adding up the assets of the banking sector (including trust and investment companies, financial leasing companies and auto finance companies), monetary authority, insurance companies, social security funds, securities companies and funds, in which the data of securities companies and funds start from 2007 and 2011 respectively.) 129

Fig 9.2 Ratio of loans of the banking sector to GDP (GDP is calculated by the expenditure method.) 129

Fig 9.3 Ratio of credits of the banking sector to GDP 130

Fig 9.4 M2/GDP ratio (the unit here is 1.) 130

Fig 9.5 Ratio of bonds outstanding to GDP 131

Fig 9.6 Ratio of treasury bonds outstanding to GDP 131

Fig 9.7 Ratio of corporate bonds outstanding to GDP 132

Fig 9.8 Ratio of market capitalization of stocks to GDP 132

Fig 9.9 Size and structure of whole society financing 133

Fig 9.10 Interbank offered rate and average lending rate 134

Fig 10.1 Total assets and total liabilities of the central bank 137

Fig 10.2 Growth of assets of the central bank 138

Fig 10.3 Ratio of the central bank’s total assets to GDP 139

Fig 10.4 Total foreign assets held by the central bank 141

Fig 10.5 Proportion of foreign assets and position for forex purchase

in the central bank’s total assets 141

Fig 10.6 Growth rate of foreign assets 142

Fig 10.7 Gold reserves held by the central bank 142

Fig 10.8 Claims of the central bank on government 144

Fig 10.9 Claims on depositaryfinancial institutions 146

Fig 10.10 Claims on other financial corporation 148

Fig 10.11 Money issue and its ratio to total liabilities of the central bank 150

Fig 10.12 Reserve money and its ratio to total liabilities 150

Fig 10.13 Central bank bonds 154

Fig 10.14 Ratio of central bank bonds to total liabilities of the central bank 155

Fig 10.15 Government deposits 156

Fig 10.16 Ratio of government deposits to total liabilities of the central bank 157

Fig 10.17 The central bank’s net claims on the external sector 158

Fig 10.18 Changes in the central bank’s net claims on the external sector (100 million yuan) 158

Fig 10.19 The central bank’s net claims on financial institutions 159

Fig 10.20 The central bank’s net claims on government 160

Fig 11.1 Structure of China’s total external assets in 2014 166

Fig 11.2 Structure of China’s reserve assets in 2014 166

Fig 11.3 Changing trends of all components of China’s external assets during 2005–2014 166

Fig 11.4 Changes in growth rates of all components of China’s external assets during 2005–2014 167

Fig 11.5 Structure of China’s external liabilities in 2014 167

Fig 11.6 Changing trends of all components of China’s external liabilities during 2005–2014 168

Fig 11.7 Changes in growth rate of China’s total external liabilities during 2005–2014 168

Fig 11.8 Total external assets and liabilities of the United States, Germany, Japan and China in 2014 170

Fig 11.9 Changing trends of net external assets of China during 2005–2014 171

Fig 11.10 Proportions of all components of total external assets of the United States during 2005–2014 172

Fig 11.11 Proportions of all components of total external assets of Germany during 2005–2014 172

Fig 11.12 Proportions of all components of total external assets of Japan during 2005–2014 172

Fig 11.13 Proportions of all components of total external assets of China during 2005–2014 173

Fig 11.14 Proportions of all components of total external liabilities

of the United States during 2005–2014 174Fig 11.15 Proportions of all components of total external liabilities

of Germany during 2005–2014 175Fig 11.16 Proportions of all components of total external liabilities

of Japan during 2005–2014 175Fig 11.17 Proportions of all components of total external liabilities

of China during 2005–2014 175Fig 11.18 Changing trends of the balance on investment income

in the current accounts of these countries over the years 176Fig 11.19 Structure of net external assets of the United States during

2005–2014 178Fig 12.1 Estimate of total income and expenditure of the old-age

insurance for urban workers 189Fig 12.2 Estimate of expenditure of the old-age insurance for urban

and rural residents 190Fig 12.3 Financial pressure of the current old-age insurance system

on the governmentfinance and the national economy 191Fig 12.4 Proportion of unreasonable income of staff of government

organs and public institutions 197Fig 13.1 The financing structure of local governments in the US 207Fig 13.2 Cashflow, interest expenses and debt repayment of urban

construction investment enterprises 209Fig 13.3 Issuance of urban construction investment bonds 210Fig 13.4 Comparison of debt ratios and liability ratios of local

governments (by the end of 2012) 212Fig 13.5 Comparison of yields on AA-rated medium-term notes

and urban construction investment bonds 213Fig 13.6 Yields on tax-exempt and taxable municipal bonds

and treasuries in the United States 213Fig 13.7 Spreads between local government bonds and treasury

bonds in the secondary market 214Fig 13.8 Outstanding debts to be repaid by government fiscal revenue

of various provinces and the issuance of local government

bonds 216Fig 13.9 Yields on 10-year treasury bonds and coupon rates of local

government bonds 217

Table 2.1 China’s national balance sheet: 2012–2013

(Unit: 1 billion yuan) 22Table 3.1 China’s simplified sovereign balance sheet: 2012–2014

(Unit: 1 trillion yuan) 32Table 4.1 Comparison between debt structure and total leverage

ratio of China and the developed economies

(ratio to GDP, %, 2014Q2) 38Table 5.1 Bonds issued by local governments in the previous years

(Unit: 100 million yuan) 53Table 5.2 Local government balance sheet: 2012–2014

(Unit: 1 trillion yuan) 55Table 5.3 Distribution of types of PPI in developing countries:

1984–2012 (number of projects) 69Table 5.4 Types of PPI in China (1990–2012, number of projects) 70Table 6.1 Simplified balance sheet of the Chinese central government

for 2012–2013 (Unit: 100 million yuan) 80Table 6.2 The central government balance sheet: 2012–2014

(Unit: 1 trillion yuan) 85Table 7.1 Assets and liabilities of enterprises in China by industry

in the years of economic censuses Unit: 100 million yuan 93Table 7.2 Assets of enterprises in China by industry in the years

of economic censuses Unit: 100 million yuan 94Table 7.3 Total assets and liabilities of non-financial corporations

in China (2000–2014) Unit: 1 billion yuan 96Table 8.1 Balance sheet of China’s household sector

(Unit: 100 million yuan) 105Table 9.1 Depository Corporations Survey for 2013

(Unit: 1 billion yuan) 110Table 9.2 Balance sheet of monetary authority for 2013

(Unit: 1 billion yuan) 111

xv

Table 9.3 Balance sheet of other depository corporations for 2013

(Unit: 1 billion yuan) 111Table 9.4 Sources & uses of credit funds offinancial institutions

in RMB for 2013 (Unit: 1 million yuan) 114Table 9.5 Balance sheet offinancial institutions converted from sources

and uses of credit funds offinancial institutions in RMB

(Unit: 1 million yuan) 117Table 9.6 Balance sheet of insurance companies for 2013

(Unit: 1 million yuan) 120Table 9.7 Simplified balance sheet of insurance companies

(Unit: 1 million yuan) 121Table 9.8 Balance sheet of securities companies for 2013

(Unit: 1 million yuan) 122Table 9.9 Simplified balance sheet of securities companies

(Unit: 1 million yuan) 123Table 9.10 Insurance companies survey (Unit: 1 million yuan) 125Table 9.11 Securities companies survey (Unit: 1 million yuan) 126Table 9.12 Balance sheet offinancial institutions including

insurance companies and securities companies

(Unit: 1 million yuan) 127Table 10.1 Basic elements of the balance sheet of China’s central

bank 136Table 11.1 China’s international investment position 2004–2014

(Unit: $100 million) 164Table 11.2 Structure and growth of China’s long-term and short-term

external liabilities during 2001–2014 (Unit: $1 billion) 180Table 11.3 Indices of China’s external liability repayment (Unit: %) 181Table 12.1 Incomes and expenditures of the old-age insurance for urban

workers during 2010–2014 and comparison with the

previous estimates (Unit: 100 million yuan) 185Table 12.2 Comparison of actual parameters and parameters used

in estimations 186Table 12.3 Ratio offinancial subsidies to the old-age insurance

tofinancial expenditure and ratio of total pension

expenditure to GDP (Unit: %) 192Table 12.4 Growth rate of per capita annual contribution

and per capita expenditure of the old-age insurance

in recent years 194Table A.1 Framework of national balance sheet 220

Part I General Report

Main Report: Leverage and Risk

Management

In 2011, when China’s local government debt problem was brought into thespotlight, foreign institutions started to voice pessimistic views on the prospects ofChina’s economy In response to this, the Chinese Academy of Social Sciences(CASS) established the national balance sheet research group in a bid to carry outin-depth analysis of the sources, status quo and development prospects of the debts

of governments at all levels and various types of economic entities in China, assessthe sovereign debt risks, judge the national capacity and explore the countermea-sures In 2012, we completed the preparation of China’s sovereign balance sheetsimultaneously with two other domestic research groups The mainfindings of thisresearch group were published in Issue 6 and 7 of Economic Research in 2013 andlater expanded into a book entitled China’s National Balance Sheet 2013—Theory,Methodology and Risk Assessment, which was published by China Social SciencesPublishing House (2013) Thesefindings have attracted wide attention at home andabroad: they have been widely cited domestically; their English versions have alsobeen included in the monograph published by IMF In 2015, the paper and the bookwon thefirst Sun Yefang Financial Innovation Award and the National Soft ScienceAward

After years of unremitting exploration, we have a deeper understanding of thestrategic decision of the 3rd Plenary Session of the 18th CPC Central Committee oncalling for the preparation the national and local balance sheets and come to akeener understanding of the indispensable role of this strategy in improving China’sgovernance capacity and modernization of the governance system Based on suchunderstanding, in 2014, with the support of the Division of Economics, weestablished the National Balance Sheet Research Center under CASS on the basis ofthe research group In 2015, after the National Finance and DevelopmentLaboratory was established upon approval by the Council meeting of CASS, andthe center became a secondary research institution of the laboratory Naturally,China’s National Balance Sheet 2015 has become one of the series annualachievements of the National Finance and Development Laboratory

© China Social Sciences Press and Springer Nature Singapore Pte Ltd 2018

Y Li et al., China ’s National Balance Sheet (2015): Leverage Adjustment and Risk

Management, https://doi.org/10.1007/978-981-10-7733-3_1

3

In this study, we continued to use the previous analytical framework and tried toupdate the key data to the end of 2014 We have focused on analyzing the track ofensuring steady growth, transforming the growth model and making structuraladjustments in China during 2012–2014, aiming to reveal the challenges in theprocess of ensuring steady growth, transforming the growth model, making struc-tural adjustments and controlling the risks We have paid particular attention to theissues concerning the adjustment of the leverage ratio and the correspondingfinancial risk management and provided the policy recommendations on how toeliminate the balance sheet risks.

China’s total assets increased from 284.7 trillion yuan to 691.3 trillion yuan during

2007–2013, an increase of 406.6 trillion yuan and an average annual increase of67.8 trillion yuan In the total assets, non-financial assets increased from158.3 trillion yuan to 336.2 trillion yuan, an increase of 177.9 trillion yuan and anaverage annual increase of 29.7 trillion yuan; financial assets increased from126.4 trillion yuan to 355.1 trillion yuan, an increase of 228.7 trillion yuan and anaverage annual increase of 38.1 trillion yuan Non-financial assets contributed43.8% to the increase in total assets, and financial assets contributed 56.2% theincrease in total assets Thus, the increase infinancial assets is the main contributor

to the increase in total assets

Furthermore, in the non-financial assets, during 2007–2013, corporate fixedassets increased by 65.2 trillion yuan, an average annual increase of 10.9 trillionyuan; residential real estate increased by 61.1 trillion yuan, an average annualincrease of 10.2 trillion yuan; government-owned resource assets (land) increased

by 30.7 trillion yuan, an average annual increase of 5.1 trillion yuan Corporatefixed assets, residential real estate and government-owned resource assets (land)contributed 36.6, 34.3 and 17.3% respectively to the increase in non-financial assetsand 16, 15 and 7.6% respectively to the increase in total assets

In thefinancial assets, deposits and loans increased rapidly during 2007–2013.Among them, deposits increased by 75.8 trillion yuan, an average annual increase

of 12.6 trillion yuan; loans increased by 64.5 trillion yuan, an average annualincrease of 10.8 trillion yuan Deposits and loans contributed 33.1 and 28.2%respectively to the increase infinancial assets and 18.6 and 15.9% respectively tothe increase in total assets

During 2007–2013, China’s total liabilities increased from 118.9 trillion yuan to339.1 trillion yuan, an increase of 220.2 trillion yuan, an average annual increase of

1 Due to the limitation of data available, the relevant estimates can only be updated to 2013.

36.7 trillion yuan In the total liabilities, deposits and loans increased rapidly.Among them, deposits increased by 75.5 trillion yuan, an average annual increase

of 12.6 trillion yuan; loans increased by 63.8 trillion yuan, an average annualincrease of 10.6 trillion yuan Deposits and loans contributed 34.3 and 29%respectively to the increase in total liabilities (financial liabilities)

In terms of net assets, during 2007–2013, China’s net assets increased from165.8 trillion yuan to 352.2 trillion yuan, an increase of 186.4 trillion yuan and anaverage annual increase of 31.1 trillion yuan; net financial assets increased from7.4 trillion yuan to 16 trillion yuan, an increase of 8.6 trillion yuan and an averageannual increase of 1.4 trillion yuan During 2011–2013, net financial assetsremained stable

In terms of the structure of assets, in 2013, for example, in the total assets,households accounted for 29.4%, non-financial corporations accounted for 30.3%,financial institutions accounted for 27.4%, and governments accounted for 12.9%;

in the non-financial assets, households accounted for 38.4%, non-financial rations accounted for 40.8%, and governments accounted for 20.8%; in thefinancialassets, households accounted for 20.7%, non-financial corporations accounted for20.2%,financial institutions accounted for 53.9%, and governments accounted for5.2%

corpo-In terms of the changing trend of debt to assets ratio at the national level, thedebt to assets ratio showed a clear upward trend during 2007–2013 and increasedfrom 41.8 to 49%, up 7.2%, an average annual increase of 1.2% Especially in

2009, 2012 and 2013, the debt to assets ratio rose significantly by 2, 3.2 and 1.5%respectively

During 2000–2014, China’s sovereign assets increased from 35.9 trillion yuan to227.3 trillion yuan, an increase of 191.4 trillion yuan, an average annual increase of13.7 trillion yuan In the 14 years, the assets of state-owned enterprise, especiallythe assets of non-financial state-owned enterprises, as well as land resources assetssaw most rapid increase Among them, the assets of state-owned enterprisesincreased by 126.4 trillion yuan, an average annual increase of 9 trillion yuan (theassets of non-financial state-owned enterprises increased by 100.2 trillion yuan, anaverage annual increase of 7.2 trillion yuan); land resources assets increased by49.5 trillion yuan, an average increase of 3.5 trillion yuan The assets ofstate-owned enterprise contributed 66% to the increase in sovereign assets (theassets of non-financial state-owned enterprises contributed 52.4% to the increase insovereign assets), and land assets contributed 25.9% to the increase in sovereignassets

During 2000–2014, China’s sovereign liabilities increased from 21.4 trillionyuan to 124.1 trillion yuan, an increase of 102.7 trillion yuan and an averageannual increase of 7.3 trillion yuan During this 14-year period, the debt of

state-owned enterprises and local government debt increased very rapidly Amongthem, the debt of state-owned enterprises increased by 55.2 trillion yuan, anaverage annual increase of 3.9 trillion yuan; local government debt increased by26.4 trillion yuan, an average annual increase of 1.9 trillion yuan The debt ofstate-owned enterprises and local government debt contributed 53.7 and 25.7% tothe increase in sovereign liabilities.

During 2000–2014, the net sovereign assets increased from 16.5 trillion yuan to103.2 trillion yuan, an increase of 86.7 trillion yuan and an annual increase of6.2 trillion yuan

According to the latest estimates, calculated on a broad-scope basis, China’ssovereign assets totaled 227.3 trillion yuan in 2014, its sovereign debt 124.1 trillionyuan, and its net assets 103.2 trillion yuan Given the poor liquidity of state-ownedassets of government organs and public institutions and the impossibility of real-izing one-time transfer of all the rights to use land and resource assets, based onnarrow-scope statistics, i.e after deducting the state-owned assets of governmentorgans and public institutions (13.4 trillion yuan) and substituting the land andresource assets (65.4 trillion yuan) by the fees of land transfer (4 trillion yuan) in

2014, China’s sovereign assets will decrease from 227.3 trillion to 152.5 trillionyuan Thus, China’s net sovereign assets calculated on the narrow-scope basis stood

at 28.4 trillion yuan In 2011, China’s net sovereign assets calculated based on thenarrow-scope basis stood at 21.6 trillion yuan Based on the above calculations,during 2011–2014, China’s net sovereign assets calculated based on thenarrow-scope basis increased by 6.8 trillion yuan, an average annual increase of2.3 trillion yuan Clearly, calculated based on either the narrow-scope orbroad-scope basis, China’s net sovereign assets were positive, suggesting that onthe whole, the Chinese government has enough sovereign assets to cover itssovereign liabilities Therefore, in a fairly long period of time, the likelihood of asovereign debt crisis in China is extremely low, but the contingent liability risksincluding the pension gap and the banks’ explicit and implicit non-performingassets deserve our close attention Once the economic growth rate continues todecline for a long time and the“contingent” liabilities continue to become “real”,China’s sovereign net asset growth trend may be reversed, and the debt risks we arefacing should under no circumstances be taken lightly

1 The central government

In terms of total assets and liabilities, in 2012 and 2013, the general central ernment’s total assets were 24.4 trillion yuan and 25.4 trillion yuan respectively, itstotal liabilities were 8.6 trillion yuan and 10.2 trillion yuan respectively, and itstotal net assets were 15.9 trillion yuan and 15.1 trillion yuan respectively In terms

gov-of structure gov-of assets, non-financial assets accounted for 34 and 30% of total assets

in the central government balance sheet in 2012 and 2013 respectively;financialassets accounted for 66 and 70% respectively, among which currencies and depositsaccounted for 12 and 16% and state-owned funds and shares accounted for 53%.State-owned enterprises’ rights and interests take a large proportion in the netassets of the central government As shown by the central government’sasset-liability structure, the central government’s total assets and net assets aremainly from the rights and interests (equity capital) formed by various forms ofinvestment of the central government in state-owned enterprises In 2012 and 2013,the rights and interests formed by various forms of investment of the general centralgovernment in state-owned enterprises were 12.2 trillion yuan and 12.8 trillionyuan respectively, and its net assets were 15.9 trillion yuan and 15.1 trillion yuanrespectively Excluding the rights and interests formed by various forms ofinvestment of the central government in state-owned enterprises, the central gov-ernment’s net assets will be reduced to 3.7 trillion yuan and 2.3 trillion yuanrespectively This means that state-owned enterprises are the main contributors tothe“massive financial reserves” in the central government balance sheet Therefore,any reform related to state-owned enterprises should be done with caution.

2 Local governments

As of the end of 2014, the total assets of local governments stood at 108.2 trillionyuan, their total liabilities 30.28 trillion yuan, and their net assets 77.92 trillionyuan In terms of the internal structure of the local balance sheet: on the asset side,land assets, outward FDI (especially rights and interests of state-owned enterprises),fixed assets and monetary funds (including treasury deposits) took a large pro-portion; on the liability side, borrowings and bondfinancing took a large propor-tion Presently, in these two items, bank loans, urban construction investment bondsand infrastructure trusts related to LGFPs still take a larger proportion In the future,after the local government debt financing mechanism focusing on governmentbonds is established and the financing function of the government in LGFPCs isremoved, the proportion of local government bonds is expected to be significantlyincreased

The size of net assets of local governments increased steadily during 2012–2014and reached nearly 80 trillion yuan Given the poor tradability of assets, especiallythe poor liquidity of land assets that account for an absolute share, this size of netassets should not be used as an effective standard for measuring local government’sability to guard against debt risks However, it should also be noted that outwardFDI, especially the rights and interests of state-owned enterprises, as the secondlargest source of assets, is equally large in size Even if government debts face somerepayment difficulties in the future, an alternative move is to convert these assetsinto a method of debt service through securitization or direct sale In addition, thehistorical cost method is mainly used to estimate the rights and interests ofstate-owned enterprises in China If the market valuation or fair value method isused, the net worth of assets and solvency of local governments will be furtherenhanced If part of realizablefinancial assets and short-term physical assets aretaken into account, then the assets owned or controlled by local governments can

fully cover their existing debts, so on the whole, local governments are basicallyfacing no insolvency risk as a result of inability to repay the debts.

However, although the local debt risk is generally controllable from the balancesheet perspective, based on the results of a comprehensive audit of government debt

at the end of 2013, particularly the comparison of the results of this audit with theresults of the audit in the mid-2011, the changing trend also reflects some riskpoints that deserve our close attention: the growth rate of debt is still high; thefinancing structure tends to be more complicated; the liquidity risk arising fromconcentrated debt maturity and payment should not be ignored; regional and sec-toral local risks deserve close attention; the existing debt repayment foundation issomewhat unsustainable; and the risk exposure of contingent liabilities is widening

3 Non-financial enterprises

After the globalfinancial crisis, the leveraging-up trend of China’s non-financialenterprises is very obvious, their debt to assets ratio has risen from 54% in 2007 to60% in 2014, an increase of 6%; their debt-GDP ratio increased from 195% in 2007

to 317% in 2014, an increase of 122% In fact, anyfinancial crisis is a debt crisis, sothis development trend of China’s non-financial enterprises must arouse dueattention

Similar to the overall performance of non-financial enterprises, state-ownedenterprises has experienced a de-leveraging process in the wake of the globalfinancial crisis During 2007–2008, the corporate debt in China was at a low level.Since then, China’s enterprises began to gradually increase their leverage As far asvarious types of enterprises are concerned, a notable fact is that the leverage level ofindustrial enterprises has not changed significantly, and since the beginning of the21st century, they have embarked on a steady and slow deleveraging process,indicating that the major changes in the assets and liabilities of nonfinancialenterprises occurred mainly in the service sector Especially after the globalfinancial crisis, their leveraging-up process has accelerated The phenomenon

reflected here and its impact on the national economic operation deserves morein-depth study

Since the beginning of the 21st century, the proportion of assets of state-ownedenterprises and industrial enterprises to total assets of non-financial enterprises inChina has declined continuously The proportion of assets of state-owned enter-prises to total assets of non-financial enterprises decreased from 43.8% in 2000 to30.2% in 2014 The proportion of assets of industrial enterprises to total assets ofnon-financial enterprises increased from 34.5 to 38.5% in 2004 and later decreasedcontinuously to 27.4% in 2014

The total assets of state-owned enterprises have increased slightly while theirproportion continued to decline, reflecting the strong rise of the private andnon-public economy as the reform is deepening The total assets of industrialenterprises have increased slightly while their proportion has declined, reflecting thebenign changes in optimization and upgrading of the industrial structure in China

4 Households

In the study period, the total expansion of total assets and net assets (total assetsminus liabilities) of households in China continued to outstrip the nominal GDP inthe same period This was mainly attributable to the continuous growth of house-hold income, the development offinancial markets and the rapid rise of prices ofassets such as housings

Housing assets remained the most important assets of households, but the ative size declined slightly Their proportion to total assets decreased from 59% in

rel-2011 to 54% in 2014, and their proportion to non-financial assets decreased from92% in 2011 to 91% in 2014 This is attributed to a slowdown in the increase in theunit price of housings, a slowdown in the expansion of urban population and otherfactors In addition, it is noteworthy that although in recent years, the total value ofurban residential housing has increased rapidly, and the increase rate is roughly thesame as that of incomes of urban households

In recent years, the total debt-to-assets ratio (debt/total assets) and financialdebt-to-assets ratio (liabilities/financial assets) of households is showing a moderateupward trend, but according to the China Financial Stability Report2published bythe People’s Bank of China, the ratio of non-performing personal consumption andbusiness loans is at a low level and remained basically stable in the same period Inaddition, in terms of the maturity structure of debt, in recent years, the proportion ofmedium- and long-term loans of households in total debt has declined, indicatingthat the short-term debt pressure of households has weakened Based on the aboveanalysis, we still maintain the judgment that the debt repayment and liquidity risk ofChina’s household sector is low on the whole

5 Thefinancial sector

With the completion of the task of economic catch-up at a quicker pace, the surge inthe prices of domestic production factors and increasing diversification and frag-mentation of market demand, it is imperative to accelerate the development ofcapital markets to achieve the historic transformation from credit products intosecuritized products Unlike creditization which mainly relies on scale expansionand risk diversification to achieve post-sharing of risk, securitization mainly relies

on effective investment andfinancing risk pricing to achieve risk-matching and risktransfer in a bid to promote the technological innovation spillover effect andassimilate the costs for increasing the prices of factors while appropriatelyimproving the risk appetite of innovation and venture investment During 2007–

2008 after the globalfinancial crisis, the assets of China’s financial sector expandedfaster than those of the United States, rapidly narrowing the gap between the twocountries in the ratio of assets of thefinancial sector to GDP In 2007, the ratio ofassets of thefinancial sector to GDP of the United States was 190.47% higher than

2 The People ’s Bank of China, May 29, 2015.

that of China, and in 2014, the gap had been reduced to 131.38% However, theaccelerated expansion of China’s financial sector after the crisis may containmultiple meanings: on the one hand, it may indicate financial deepening, whichrepresents an increase in the level offinancial development; on the other hand, itmay indicate excessive accumulation offinancial risk and excessive expansion ofinternal transactions within thefinancial system not related to the real economy Forthe latter, we clearly need to stay vigilant.

6 The external sector

In 2014, China’s external sector balance sheet continued to expanded significantly

on the whole, total external assets and total external liabilities continued thegrowing trend that had been maintained over the years, and net external assetsdeclined slightly by about 11% compared to 2013 The structure of external assetsand liabilities tended to be reasonable, the proportion of foreign exchange reserves

in total external assets continued to decline, the proportion of inward FDI in totalexternal liabilities also continued the downward trend, reflecting “foreign exchan-ges held by the people”, diversified use of foreign funds and other positive changes.The external sector balance sheet reflects the cumulative effects of long-termexternal economic activities As China’s economy continues to develop and tradeopenness andfinancial market-orientation degree continue to improve, the ratio ofChina’s total external assets and total external liabilities to GDP will continue torise The net position of China’s external assets is positive, and China has accu-mulated huge official reserves and a low level of external debt, so the likelihood of asovereign debt crisis in China is extremely low Presently, the main risks China isfacing in its external assets and liabilities are currency and asset mismatch risks.Despite the years of efforts, the two-wayfloating of RMB exchange rate has beensignificantly enhanced, short-term currency mismatch will not lead to any externaldebt risk, but as China’s external assets denominated in foreign currencies aremainly held by the monetary authorities, the currency mismatch risk may have animpact on the domestic monetary policies and thus have a greater negative impact

on the domestic financial system Finally, China’s external liabilities are mainlyinward FDI in China with higher costs, while its external assets are mainly officialreserves with lower returns, leading to long-term negative returns on investment ofChina’s external assets.3In view of this, China should continue to actively optimizeits external asset-liability structure, take necessary measures as soon as possible todeal with the currency and asset mismatch risks reflected in the balance sheet in abid to improve the rate of return on external assets and improve its externalasset-liability structure

3 By comparison, the external liabilities of the United States are mainly low-cost securities investments, while its external assets are mainly high-yield foreign equities Due to such structure, even though the United States is a net debtor, its investment returns are positive for a long time.

1.2 Leverage Adjustment and Risk Management

In this report, we have estimated the level of leverage in China as a whole and thelevel of leverage of all sectors In order to avoid ambiguity, we need to give a briefexplanation to the statistical scope we have chosen and the reason why we havechosen it, especially for its distinction and relevance with the statistical scopesadopted by other relevant institutions

In recent years, a number of international institutions probably have made anestimation of the leverage ratio in China, of which the estimates of McKinsey &Company in the United States are most influential Basically, the preparation of thebalance sheet does not involve sophisticated theoretical issues, so if there are dif-ferences between the results, there are probably two technical reasons:first, dif-ferent items are selected; second, different valuation methods are used Thesetechnical differences are related to the purposes of preparation Usually, the balancesheet preparers will positively exclude some items in order not to prevent theirprincipal analysis objects from data interferences

According to McKinsey’s estimate, China’s financial sector has a higherleverage ratio, and our estimate is much lower The fundamental difference lies in:first, the main purpose of estimating the leverage ratio is to assess the risks, whilecurrencies and deposits in thefinancial sector do not constitute the main risk of thefinancial sector or the risk is small, so the research group only deems the out-standing bonds issued by thefinancial sector as its debt But based on McKinsey’sapproach, the debt/GDP ratio is calculated by adding up the two items of“Claims

on Other Depository Corporations” and “Claims on Other Financial Institutions” inthe balance sheet of “other depository corporations” issued by the central bank,increasing the leverage ratio of the financial sector.4 Second, in terms of riskmanagement, what really deserves our attention is the leverage ratio of the realsector Third, due to the differences in thefinancial systems in different countries,there is poor comparability among the leverage ratios of theirfinancial sectors Infact, McKinsey has also used the leverage ratio of the real sector when makinginternational comparisons

In short, the research group’s choice of data of the financial sector is to moreclearly understand the risks China is facing and to enhance international compa-rability according to the international practice

4 In the statistics of the People ’s Bank of China, the data on “Claims Other Depository Corporations ” before 2005 are not available, so McKinsey’s statistics has poor comparability.

1.2.2 Whole Society Leverage Ratio

Based solely on the balance sheet, we will not be able to fully assess debt tainability The primary source of debt repayment is not the financial assets cur-rently held, but the future cashflow However, this can not be fully reflected in thebalance sheet For example, the debt of households is primarily repaid by wageincome, while the assets of the majority of households are non-financial assets(residential housings) Similarly, start-up companies usually have only a smallamount of assets, but they are expected to have ample future cashflows For banks,the quality of loan assets is mainly determined by borrowers’ future cash flows Forgovernments, most governments have only a small amount offinancial assets andhold a large amount of non-current non-financial assets, and they will pay theirdebts mainly through the operating income of these illiquidfinancial assets If there

sus-is a gap, taxes and other public revenues should be used Therefore, after ering a number of relevant factors, the debt to income ratio is considered to be themost important indicator for measuring debt sustainability This is why is the wholesociety leverage ratio has aroused great attention worldwide This is because, for thewhole society, GDP constitutes the main income, while the debt to GDP ratio is thewhole society leverage ratio

consid-We have estimated the leverage ratios of the four sectors of households,non-financial corporations, governments and financial institutions and added them

up to get the whole society leverage ratio By the end of 2014, the debt of China’sreal sector (excluding financial institutions) stood at 138.33 trillion yuan, and theleverage ratio of the real sector was 217.3% By the end of 2014, the debt ofChina’s economy as a whole (including financial institutions) stood at 150.03trillion yuan, and the whole society leverage ratio was 235.7% (based onMcKinsey’s estimation approach, by the end of 2014, the debt of China’s economy

as a whole was 177.53 trillion yuan, and the whole society leverage ratio was ashigh as 278.9%)

After the outbreak of thefinancial crisis, the total debt of all sectors to GDP ratioestimated by the approach of the research group increased from 170% in 2008 to235.7% in 2014, up 65.7% in 6 years The total debt of all sectors to GDP ratioestimated by McKinsey’s approach increased from 184.6% in 2008 to 278.9% in

2014, up 94.3% in 6 years Iffinancial institutions are excluded and only the change

of the leverage ratio of the real sector is taken into consideration, then China’s debtratio will increase from 157% in 2008 to 217.3% in 2014, up 60.3% in 6 years,which is also an obvious upward trend Among them, the ratio of total debt ofhouseholds to GDP increased from 18.2 to 36%, up 17.8%; the ratio of total debt ofnon-financial corporations to GDP increased from 98 to 123.1%, up 25.1%; theratio of total debt of governments to GDP increased from 40.6 to 58%, up 17.4%.During 2008–2014, households, non-financial corporations and governments con-tributed 29.5, 41.6 and 28.9% respectively to the increase in the total leverage ratio

of the real sector

In a longer period of time, i.e during 1996–2014, the total debt of all sectors toGDP ratio estimated by the approach of the research group increased from 113 to235.7%, an increase of 122.7% in 18 years and an average annual increase of 6.8%.Among them, the ratio total debt of households to GDP increased from 3.1 to 36%, up32.9%; the ratio total debt of non-financial corporations to GDP increased from 83.7 to123.1%, up 39.4%; the ratio total debt offinancial institutions to GDP increased from3.5 to 18.4%, up 14.9%; the ratio total debt of governments to GDP increased from22.7 to 58%, up 35.3% During 1996–2014, households, non-financial corporations,financial institutions and governments contributed 26.8, 32.1, 12.1 and 28.8% respec-tively to the increase in the whole society leverage ratio Obviously, non-financialcorporations and governments mainly accounted for the increase in debt ratio in Chinaduring this period.

Buttiglione et al (2014) pointed out that before 2008, the increase in globalleverage ratio was mainly attributed to the developed countries, but since then, theincrease in global leverage ratio was mainly attributed to the developing countries.This means that the next debt crisis may occur in a developing country As theworld’s largest developing country, China is in the process of increasing leverage.For this ominous foretelling, we must keep fully alert

The rise in leverage ratio has become an important driver of bubbles and resourcedistortions and has sown the seeds for future crises Therefore, deleveraging hasbecome an essential part of economic adjustment From leveraging to deleveraging,the leverage ratio itself is also experiencing its unique cycle To master the char-acteristics of this cycle, particularly to understand its “self-strengthening” charac-teristics, is the prerequisite to cope with the soaring leverage ratios

Theoretically, the leverage cycle typically begins with significant innovationssuch as a technological breakthroughs that can significantly improve productionfunctions, creation of new products or financial innovations that create new mar-kets, or major institutional changes These innovations have promoted directly tothe increase in total supply and the increase in economic growth, which have led tooptimistic expectations on the economic outlook Based on optimistic expectations

of future economic growth and income, households, companies and governmentstend to overestimate their debt sustainability and are willing to take on more debts,the credit of the entire economy is expanding rapidly and the debt rate is riskingrapidly For the past 50 years, most of the “economic miracles”, including theItalian Miracle, the South American Miracle, the Japanese Miracle, the SoutheastAsia Miracle, the American Miracle, the Irish Miracle, the Spanish Miracle, theChinese Miracle and so on, are in essence driven by innovations and a subsequentrapid growth period supported by credit expansion The reasons for the fall of these

“miracles” are also very similar: the positive impact of innovation on output wasgradually weakened, the excessively radical leverage ratios were far beyond their

own debt affordability, and the overly tight debt relationships werefinally broken in

a weak link, causing various forms offinancial crises, and the high growth periodsthen came to an end

As shown in Fig.1.1, there is a positive feedback mechanism between economicgrowth and leverage ratio When the expected income increases, people tend toborrow more money, and these borrowings will directly promote the increase indemands, resulting in self-realization of expected increase in income But in fact,this situation has blurred and expanded expectations for the economic outlook.David (1989) pointed out in his study that in the process of assimilation of tech-nological innovation, the output will show an S-curve growth: economic growth isslow initially; it will accelerate with the spread of new technologies in the economy;with the “dividend” effect of technology becomes weakening, economic growthwill slow down again Credit expansion to a certain extent will extend the time ofrapid growth, thus delaying people’s expectations for economic slowdown Whenexpectations reverse, people will be aware that the economic outlook is gloomy, theactual debt sustainability or future cashflow is significantly lower than previouslyexpected, the existing debt has exceeded the ability to repay, the debt risk is thusgreatly increased, so a debt crisis is likely to be triggered

Faced with such situation, there are three possible prospects or solutions:Thefirst prospect is that debts are repaid or can not be renewed after expiration,debt defaults commonly occur in economic entities or a large number of debtdefaults (or in a more subtle way, such as inflation etc.) occur in major departments,

a crisis breaks out, and the total output and growth rate are significantly reduced.The second prospect is to release the risks by leveraging Because of the positivefeedback between economic growth and leverage ratio, even a slow deleveragingprocess will also have a negative impact on the economic recovery However, if themacro-control authority can realize an inevitable dilemma between deleveragingand ensuring steady growth and take appropriate macroeconomic policies to dealwith it, the negative impact of deleveraging on the output can be gradually released,and after some time, the economy will slowly stabilize

The third prospect is most attractive That is, the government clearly states that itwill head in the direction of improving production efficiency and issue a variety of

Fig 1.1 Various stages of a leverage cycle Source Buttiglione et al (2014)

policies to guide the economy and the society to strongly promote structuralreforms and resolve the debt burden through economic growth In this process, thequality and efficiency of economic growth will be steadily improved.

In reality, the solution is often a three-pronged approach, and its actual effect ismainly dependent on the degree of improvement of production efficiency In thissense, unswervingly promoting the structural reforms is undoubtedly the best policy

to get rid off the bad inertia of leverage cycle

Growth: Molecular Countermeasure

and Denominator Countermeasure

The recovery from a crisis depends on the success of deleveraging, but the nomic downturn caused by the deleveraging process has blocked the recovery from

eco-a crisis, which is the dilemmeco-a between delevereco-aging eco-and steeco-ady growth Therefore,the management of the deleveraging process is a serious challenge to the policyauthorities

The most intuitive way to consider a leveraged policy is to start with the formula

of debt ratio = debt/income According to this formula, the adjustment of the debt

to income ratio may come in two types: “molecular countermeasure” and nominator countermeasure” The adjustment of the denominator (i.e., the debt)includes gradual repayment of debt, reduction of debt, debt undertaking by thegovernment or the central bank and reduction of interest expenses The adjustment

“de-of the denominator includes structural reforms, expansion “de-of real GDP andexpansion of nominal GDP via inflation scale

Debt reduction measures may lead to lower incomes, making it difficult toachieve deleveraging For example, it is hoped that leverage can be reduced bygradually repaying debts or reducing the issuance of new debts, and as there is apositive feedback mechanism for credit-income, debt reduction may lead to adecline in GDP growth For another example, thefiscal austerity policy adopted inorder to reduce government debt tends to result in short-term income tightening,and as its impact on the income growth mechanism is so significant that the gov-ernment is likely to give it up halfway

Although direct debt reduction can reduce debts, it will also have negativeeffects The debt of someone is the asset of another person, so that the direct loss ofthe value of assets and the spillover effect on the other markets cause by debtreduction will have a direct negative impact on economic expansion More seri-ously, credit default events may suppress the confidence of market participants, andthus market participants may require a higher risk premium, resulting in shrinkage

of social credit

The government or the central bank takes on the debts For example, in thiscrisis, the US government took over Fannie Mae and Freddie Mac and the Federal

Reserve bought mortgage-backed securities, and such measures are economicallyequivalent to debt reduction The former means that the future tax burden willincrease (to repay the added treasury securities), and the latter is an interventionpolicy with medium-term effect because the People’s Bank of China will shrink thebalance sheet at a certain point in the future (preferably when the economic situ-ation has improved) to make it return to its normal size, otherwise it will facelong-term inflationary pressures The huge differences between the division of the

“bailout” policies adopted by Europe and the United States after the outbreak of thecrisis and the bailout effects have given a better interpretation of such ideas on

“bailout” In Europe, due to the failure of the government or the central bank totimely take on the debts, particularly, the failure to timely implement the quanti-tative easing policy, serious credit squeeze has occurred in the euro zone, and theeconomic growth was seriously damaged, so up to now its economic recovery isstill faltering On the contrary, in the United States, due to timely and decisiveadoption of the stimulus measures, the economy has basically restored creditexpansion shortly after the crisis, and although its recovery process is not ideal, atleast a second round of severe downturn was avoided It seems that the government

or the central bank’s taking over social debts is after all a second-best choice to bailout the economy from a crisis

Through the policies such asfinancial suppression, we can encourage the public

to hold government bonds and thereby reduce the interest expenses of governmentdebt

In summary, by comparing molecular countermeasure and denominator termeasure, it is obvious that the latter has a permanent effect Therefore, mostcountries that are heavily indebted and have received the bailout and guidance fromIMF since the crisis have committed to carrying out structural reforms to achievemedium- and long-term real output growth For example, after a wide range ofroundabout in the recent debt crisis, Greek has to re-take the road to reform forbailout This tells us that carrying out reforms and thus maintaining a certain level

coun-of growth is still the key to solving all the problems In contrast, in the variouspolicies of molecular countermeasure, the government and the People’s Bank ofChina took over the debts This at least has the effect of smoothing a crisis and canextend the time window for bailout, which is a feasible short-term Palliativemeasure, while the effects of other policy instruments were not significant

Management

China’s national balance sheet is generally relatively healthier, but there are stilllocal risks, which are mainly reflected in the overly high leverage ratio ofnon-financial corporations and local governments Correspondingly, there is still

space for China’s households and central government to add leverage (see theanalysis in Chap.4) Based on this structure, in the process of deleveraging, it is afeasible policy choice to try to eliminate local risks through leverage adjustment andtransfer.

In fact, so far, the policy authorities have also been performing along this track

of thought, which is mainly reflected in two aspects First, the leverage of localgovernments is being transferred to the central government That is, local gov-ernments are reducing leverage, while the central government is adding leverage.Given that the leverage ratio of local governments is currently 42.7%, while that ofthe central government is only 15.1%, such transfer is objectively possible Theswap of local debt is an example In addition, the transfer of liabilities from LGFPs

to the policy-orientedfinancial institutions (such as CDB) is also another form oftransferring leverage from local governments to the central government Second,the leverage of enterprises is being transferred to households The most typical form

is the development of the stock market If the stock prices continue to rise, thenominal value of equities of enterprises will increase on the one hand through therise in stock prices, and on the other hand, the equities of enterprises will increasethrough seasoned equity offering or IPO If the leverage level is measured by thedebt to assets ratio, the total results of the above activities will significantly reducethe leverage ratio of enterprises However, we do not appreciate the practice ofshifting the leverage of enterprises to households and strongly disagree on the

“strategy” to further increase the equities and reduce the leverage of enterprises bydriving up stock prices or through seasoned equity offering or IPO In June–July

2015, the stock marketsfluctuated violently, which gives a negative evaluation onthis track of thought

The relationship between leverage adjustment (or transfer) and financial riskmanagement and be analyzed based on the following ideas

In reality, there are four types of leverage adjustment or transfer First, thetransfer between governments, for example, the transfer from local governments tothe central government Second, the transfer from the government to the privatesector The typical practice is the market-oriented sharing of government debt, such

as imposing the inflation tax If state-owned enterprises are included into thegeneral government, then financing of state-owned enterprises through the stockmarket can also be classified into this category Third, the transfer from the privatesector to the government For example, the sovereign debt crisis triggered by thesubprime mortgage crisis of the US real estate sector forced the Fed to implement

QE This is to realize deleveraging of the private sector through the leveraging ofthe government Fourth, the private to private transfer, such as the deleveraging ofenterprises (mainly non-state-owned enterprises) and the leveraging of households.Without doubt, each of the above these circumstances may contain risks orchallenges First, the transfer of leverage between governments The risk is small onthe whole, which is precisely the advantages of the Chinese system A series ofmeasures to deal with the bad debts of banks at the beginning of the 21st century,

such as the establishment of asset management companies, the issuance of specialtreasury bonds, the injection of foreign exchange reserves to banks, the re-lending

of the People’s Bank of China, are a typical model of leverage transfer betweengovernments Due to the unity of China’s political system, such transfer is mainlythe top-level decision made by the central government, so there is on obstacle insystem Second, the transfer from the government to the private sector Regardless

of“imposing the inflation tax” or financing of state-owned enterprises through thestock market, the policy authorities need to consider the resulting social costs, andthe effects are also highly uncertain Third, the transfer from the private sector to thegovernment The transfer of the leverage of the private sector to the government isnot a rare case, especially during a crisis, but there are also serious soft constraintsand moral risks, such as the issues of “Too Big to Fail”, whether the bailout ofLehman Brothers is necessary and whether the government should bail out whenthe stock market is facing collapse Objectively speaking, there is a causal linkbetween government bailout and government intervention If government inter-vention precedes government bailout, then government bailout will become anunavoidable follow-up measure and responsibility Therefore, to control the risks inthe process of transferring the leverage of the private sector to the government, it isnecessary to clarify the rules and respect the market Of course, when systemic riskshave been found, the government is duty-bound assume the role of thefinal lender.However, this has involved the issue of crisis management Fourth, theprivate-to-private transfer Such transfer should be based on the law of the market,and excessive government intervention should be avoided The responsibility of thegovernment is to maintain a good market order, and even if the government needs

to provide guidance, it should also follow the“market determinism” and provideguidance according to the contractual spirit

The above is the “sandbox deduce” we have made to introduce the train ofthought that the leverage is transferred within a country to weaken the surge ofleverage ratio and managefinancial risks It aims to show that under the backgroundthat when China’s national balance sheet is still healthy, we have conditions toweaken the risks arising from the soaring of leverage ratio in some local areas andsome sectors However, when we happily accept this result, we must be soberlyaware that we will also be restricted by other conditions in the adjustment ofleverage ratio in reality For example, in the balance sheet, the liabilities are rela-tively rigid while the assets are likely to change constantly For an example, underthe condition of stock market expansion, the equity financing of non-financialcorporations may increase, and the scale of assets of enterprises will be expanded.However, the opposite process may also occur: when the stock market falls, the size

of assets of enterprises will shrink sharply In other words, the size of the assets ofnon-financial corporations may change dramatically, but the liability side is “mo-tionless” In the process of leverage transfer, we must keep this feature in mind

1.2.6 The Fundamental Way Out Is to Change the Mode

of Economic Development Through Reform

The structural risk of China’s current balance sheet is mainly characterized bymaturity mismatch, capital structure mismatch and currency and asset mismatch.These mismatches are related to both the developmental stages and the institutionaldistortions Therefore, the fundamental approach to solve the balance sheet risks is

to adjust the economic andfinancial structures and change the mode of economicdevelopment

Maturity mismatch is mainly reflected in the local balance sheet AlthoughChina’s local governments are not facing the problem of insolvency, the liquidityrisk of their balance sheets is extremely serious due to serious maturity mismatch.The maturity mismatch of local government balance sheet is mainly due to the factthat most of the assets of local governments have a longer maturity (infrastructureand public service investment), while on the liability side, they lack sustainablesources of long-term capital To solve the problem of maturity mismatch, we need

to take comprehensive measures As an integral part of these measures, we shouldestablish a stable urban infrastructure investment and financing mechanism, vig-orously promote the development of long-term credit financial institutions andpolicy-oriented financial institutions and actively adjust the match the financialrelations between the central and local governments based on the principle ofmatching between income and expenditure responsibilities

Capital structure mismatch is mainly reflected in the balance sheet ofnon-financial corporations Its basic reflection is that the liability ratio is too high.This is closely related to China’s financial structure Indirect financing throughbanks is the dominatedfinancing mode in China and constitutes the basic charac-teristics of China’s financial system As bank credit can only be provided by means

of loans, enterprises’ heavily relying on bank loans to finance will inevitably lead tothe increase on their liability ratio The fundamental solution is to seriouslyimplement the decision of the 3rd Plenary Session of the 18th CPC CentralCommittee, which states that “we will improve the multi-layer capital marketsystem, promote reform toward a registration-based stock-issuing system, promoteequityfinancing through diverse channels, develop and regulate the bond market,and increase the proportion of directfinancing.” In the meanwhile, we should alsore-examine the provisions prohibiting commercial banks from engaging in invest-ment activities in accordance with changing circumstances and conditions.Currency to asset mismatch is mainly reflected in the external balance sheet Itsconcentrative reflection is that the difference between the investment returns ofChina’s external assets and external liabilities (offset balance between China’soutward FDI and inward FDI of foreign countries in China) has been negative for along time To reverse such mismatch, we should steadily promote the structureadjustment of capital and financial account from the two aspects of currencystructure and asset structure in the process of easing the control over capital andfinancial account On the liability side, we should increase the proportion of RMB

in China’s external liabilities and gradually reduce the costs our external liabilitiesthrough internationalizing RMB, promoting the One Belt and One Road Initiativeand building the FTAs On the asset side, we should lay emphasis on expandingdomestic demands, slow down the accumulation of foreign currency-denominatedassets (especially credit assets); vigorously promote outward FDI and securitiesinvestment (especially equity investment) while implementing the strategy of

“foreign exchanges held by the people” and increase the holding of assetsdenominated by the currency of the country as the investee so as to share thebenefits of its economic growth

Chapter 2

National Balance Sheet

According to the System of National Accounts (SNA2008) and the preparationmethod of the National Bureau of Statistics (2007), we have tentatively preparedChina’s national balance sheet of 2012–2013 using publicly available data andnecessary estimates on the basis of preparation of China’s national balance sheet of

2007–2011 It should be noted that since the flow of fund accounts which thepreparation is based on were released much later, we are unable to update thenational balance sheet to make it time-consistent with the following sectoral balancesheets

The asset side of national balance sheet includes the two major items ofnon-financial assets and financial assets Non-financial assets include residents’ realestate and automobiles, rural productive fixed assets, cooperate fixed assets,inventories, administrative institutions’ fixed assets, public institutions’ intangibleassets and government-owned resource assets (land);financial assets include cur-rencies, deposits, loans, bonds, stocks, securities investment fund shares, clients’margins of securities companies, insurance reserves, settlement funds, transactions

offinancial institutions, reserves, cash holdings, lending of the central bank, otheritems (net), foreign direct investment, other external claims and obligations, andinternational reserve assets

The liabilities side includes currencies, deposits, loans, bonds, stocks, securitiesinvestment fund shares, clients’ margins of securities companies, insurancereserves, settlement funds, transactions of financial institutions, reserves, cashholdings, lending of the central bank, other items (net), foreign direct investment,other external claims and obligations, international payment errors and omissionsand other items By definition, liabilities refer only to financial liabilities, withoutphysical counterparts The difference between assets and liabilities is net assets,which corresponds to the owner’s equity or capital in the financial statements ofenterprises

© China Social Sciences Press and Springer Nature Singapore Pte Ltd 2018

Y Li et al., China ’s National Balance Sheet (2015): Leverage Adjustment and Risk

Management, https://doi.org/10.1007/978-981-10-7733-3_2

21

Here are some explanations about the estimates: (1) non-financial assets mainlyinclude the relevant assets of the subsectors such as households, non-financialcorporations and governments (2) The basic method to estimatefinancial assets andfinancial liabilities is to add up the data of the domestic sectors in the flow of fundsaccounts (financial transactions) of 2012 and 2013 jointly published by the NationalBureau of Statistics (NBS) and the People’ Bank of China (PBC) on the basis of thenational balance sheet of 2011 we have prepared previously We did not use thesectoral accumulation method because it is difficult to ensure complete corre-spondence and matching between assets and liabilities through direct accumulation

as there may be differences in the estimation methods and data sources of varioussectors

According to the above estimation method, Table2.1 lists China’s nationalbalance sheet of 2012–2013

Based on the national balance sheets prepared previously and above, totalnational assets increased from 284.7 trillion yuan to 691.3 trillion yuan during

2007–2013 (see Fig.2.1), total liabilities increased from 118.9 trillion yuan to

Table 2.1 China’s national balance sheet: 2012–2013 (Unit: 1 billion yuan)

Financial assets 303361.3 355067.3 Financial

liabilities

287367.2 339073.2 Currencies 5273.126 5664.626 Currencies 5511.32 5902.82 Deposits 99355.05 115039.05 Deposits 99370.15 115054.15

Stocks 11428.947 11925.847 Stocks 12478.381 12975.281 Securities

investment fund

shares

1739 1874.2 Securities

investment fund shares

financial institutions 3758.517 5195.217 Transactions offinancial

institutions

5248.577 6685.277

Reserves 18189.63 19619.83 Reserves 17940.96 19371.16 Cash holdings 560.353 604.553 Cash holdings 1032.691 1076.891 Lending of the

339.1 trillion yuan (see Fig.2.2), and net assets increased from 165.8 trillion yuan

to 352.2 trillion yuan (see Fig.2.3) Of the total assets, non-financial assetsincreased from 158.3 trillion yuan to 336.2 trillion yuan (see Fig.2.4),financialassets increased from 126.4 trillion yuan of to 355.1 trillion yuan (see Fig.2.5),and netfinancial assets increased from 7.4 trillion yuan to 16 trillion yuan, whichremained stable during 2011–2013 (see Fig.2.6)

investment

4102.768 6147.068 Foreign direct

investment

12676.58 14720.88 Other external

claims and

obligations

5019.434 6161.134 Other external

claims and obligations

non- financial assets

Unit: 1 billion Yuan

Fig 2.1 Size of total national assets: 2007–2013 Source Estimates of the research group

Unit: 1 billion Yuan

Fig 2.2 Size of total national liabilities: 2007–2013 Source Estimates of the research group

Unit: 1 billion Yuan

Fig 2.3 Size of net national assets: 2007–2013 Source Estimates of the research group

Unit: 1 billion Yuan

Fig 2.4 Size of national non-financial assets: 2007–2013 Source Estimates of the research group

Unit: 1 billion Yuan

Fig 2.5 Size of national financial assets: 2007–2013 Source Estimates of the research group

Unit: 1 billion Yuan

Fig 2.6 Size of net national financial assets: 2007–2013 Source Estimates of the research group