A long battle to put 'leverage ratio' genie in bottle

At a time when the leverage ratios of major economies like the United States, European Union and Japan tend to decrease, China's macro-leverage ratio has steadily risen.

A specter is haunting China’s financial sector, the specter of leverage ratio.

At a time when the leverage ratios of major economies like the United States, European Union and Japan tend to decrease, China’s macro-leverage ratio has steadily risen.

Leverage ratio is the percentage of debt in the balance sheet of a single economic entity, such as a household or a firm.

According to official statistics, as of 2017, China’s macro-leverage ratio reached 248.9 percent, approaching the US’s 251.2 percent and the Eurozone’s 258.3 percent.

Heightened concerns about the continued increase of leverage ratio over the past few years have been the driving force behind China’s efforts to deleverage its economy.

At a recent forum held by Fudan University’s School of Management, the issue of leverage ratio again drew the attention of many famed scholars.

One of them is Li Yang, chairman of National Institution for Finance & Development, a government-affiliated think tank. In his speech he equated high leverage ratio with high financial risk. “Many of the economic issues today, such as debt problems and worsening balance sheets of companies, can all be ascribed to the leverage ratio,” said Li.

He noted that China’s financial authorities are confronted with a daunting “long-running” task of mitigating risks arising from an over-leveraged economy. The reason he believes that deleveraging the economy will take longer than expected is twofold. China is now caught in an economic downturn as an inevitable part of the boom-and-bust economic cycle that began since the 2008 global financial crisis.

Li explained that China needs to brace for a sustained period of moderated growth marked by struggles to service debts incurred by firms, households and even governments.

Complicating the debt woes is the possibly prolonged China-US trade war, in spite of their recent 90-day ceasefire that postpones the imposition of new tariffs on Chinese import due to go into effect in January.

“If we compare notes, deleveraging is globally a long-term endeavor,” said Li, adding that the US serves as a reference. It took the country almost eight years to bring down the country’s leverage ratios from the peak levels since the financial meltdown.

A breakdown of China’s debts indicates that a big part comes from soaring household debts on the back of a real estate boom. Still, they are considered to be within safety limits, said Li.

A few years ago ballooning local public debts sparked widespread concerns of a government default, but that scenario has been staved off as the central government rolled out policy measures aimed at curbing excessive borrowing by local governments through numerous financing platforms.

The real difficulty lies, again, in dealing with the state-owned enterprises.

Li explained that many loss-making, insolvent SOEs continue to be chiefly responsible for a spike in public debts, and policy-makers are now widely anticipated to lay to rest the intractable issue of so-called “zombie enterprises” over the next three years.

China’s debt levels perked up immediately following the 2008 massive stimulus package, and the lingering fallout can still be acutely felt, Li said.

Over the medium to long term, the scholar observed that management of financial risks should proceed in tandem with a series of reforms to overhaul China’s financial sector.

He outlined a few key areas in need of deepening reform measures, such as interest and exchange rate liberalization.

A long-term advocate for financial technology, or fintech, Li reflected on the trajectory of fintech’s development in China, tracing its origins to 2013 when a handful of IT companies became involved in Internet banking or peer-to-peer lending.

Subsequently, application of big data and cloud technology has given China a headstart in the current global fintech revolution. Li believes that the next phase of financial overhaul should highlight the need for financial inclusion, to help deliver financial services to millions of still unbanked population within the country.

“Financial inclusion is essentially about providing proper and efficient financial services to the social groups most in need,” he said. “And it should be done in a way that respects their dignity.”

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