China's Rising Household Debt May Build Medium-Term Risks


Thursday, March 29, 2018 /07:55 AM / Fitch Ratings 

The continued rapid rise of China's household debt burden could provide the authorities with more time to rein in corporate leverage without jeopardising growth targets, but would not resolve the economy's underlying reliance on credit and may create medium- to long-term risks of its own, says Fitch Ratings.

Bank lending to households has expanded by a compounded average of 20% a year since 2011. It has become a particularly important driver of economic growth in the past year, as it has continued to rise strongly even as regulatory scrutiny of shadow banking and interbank activity has tightened credit conditions for the corporate and financial sectors. Indeed, household debt became the largest component of new credit in the banking system for the first time in 2017, accounting for more than half of new loans.

The run-up in household leverage over the previous decade has been from a low base and partly reflects financial deepening as the economy and housing market have developed. We estimate that China's household debt reached 82% of disposable income at end-2017, up from 31% at end-2008. This remains below levels in most developed economies and suggests that any near-term market concerns over China's household debt burden are probably overblown.

However, China's household balance sheets do appear more stretched than those in most emerging markets and the gap with developed markets could narrow quickly if left unchecked. Fitch estimates that the household debt-to-disposable income ratio could reach close to 100% by 2020 if current trends persist, effectively closing the gap with the US (105%) and Japan (99%). Moreover, rapid growth in mortgage lending, which accounts for the bulk of household debt, appears to contain pockets of speculative activity, as highlighted in statements by senior government leaders.

Unabated growth in household debt could create vulnerabilities in the financial system, particularly if coupled with looser credit standards. So far, lending standards generally appear to have remained prudent, while downpayment requirements have been tightened since mid-2016. The maximum loan-to-value ratio is 70% for first-time buyers and many mortgages appear to be originated under even tighter terms. That said, collateral valuation is an important downside risk, given rapid price appreciation in the previous few years. Some banks could eventually face rating action if loss-absorption capacity is not increased to reflect rising risks related to household lending.

The Chinese authorities would almost certainly use policy levers to stabilise the housing market in the event of a downturn, although such a scenario is currently well outside Fitch's baseline forecasts. For example, housing purchase restrictions could be rolled back and there is considerable room to lower payment requirements. Other policy measures that directly influence prices or supply-demand dynamics are also possible, since policymakers appear to be increasingly treating housing-market stability as systemically important. However, heavy intervention could dull the role of market forces and the utility of price signals across the economy over the longer term, and may not necessarily achieve the desired effects in the short-run.

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