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China's Road to Greater Financial Stability

Chapter 4. China’s Sovereign Balance Sheet Risks and Implications for Financial Stability

Udaibir Das, Jonathan Fiechter, and Tao Sun
Published Date:
August 2013
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To examine China’s sovereign balance sheet and its potential risk factors relevant to financial stability, this chapter presents a stylized balance sheet for the period from 2000–10 to show that sovereign equity has gradually grown, implying a low probability of a sovereign debt crisis in China. The chapter then discusses China’s overall debt-to-GDP ratio (leverage ratio), which is higher than those in other G20 emerging market economies and therefore warrants policy attention, and also analyzes the related structural and institutional aspects relevant for management of the sovereign balance sheet.

The chapter finds that short-term sovereign balance sheet risks in China have emanated mainly from housing credit and local government debts, while medium-to-long-run risk can be attributed to the external sector, corporate debt, and underfunded social security liabilities. These risks are mostly contingent in nature and rooted in China’s development model. Finally, the chapter simulates the debt dynamics and shows the importance of maintaining relatively higher GDP growth and thus a positive gap between the GDP growth rate and the interest rate. Transforming the development model, thus, will be the fundamental way to mitigate the risks on the sovereign balance sheet and their potential spillovers onto the financial system.


History shows that an economic crisis is often coupled with a debt crisis. With the deepening globalization and growing importance of the financial sector, the dimensions of a debt crisis have gone beyond its traditional fiscal components to include financial stability aspects as well. A proper analysis of sovereign-held financial assets and liabilities is thus vital to better understand the causes and development of the crises and the needed set of policy responses. Indeed, sovereign balance sheet issues are being given greater weight in recent economic literature, as crisis periods since 1980 could be regarded as balance sheet shocks.

In China, the recent development of local government financing vehicles (LGFV or di fang rong zi ping tai) have triggered concerns about the country’s sovereign debt risk. Some international and Chinese observers have even predicted LGFVs could potentially be a cause for the collapse of the Chinese economy. A sovereign-balance-sheet-based analysis helps examine the assets, liabilities, and net worth of China’s public sector, and to clarify the relationships among various economic activities. Since the associated accounting is mainly based on stock rather than flow variables, balance sheet analysis can provide an alternative perspective on the cumulative effects of economic growth over the past decade. In particular, with the help of sectoral balance sheets, the stock-based study is of great interest for investigating the diverse features associated with the ongoing structural transformation and institutional changes in China.

Compiling a sovereign balance sheet is not a recent trend. In 1936, two American researchers, Dickinson and Eakin (1936) first applied a corporation’s balance sheet framework to undertake macroeconomic analysis. However, this novel perspective became popular in the 1960s mainly due to the work of Goldsmith and Lipsey (1963) and Goldsmith (1982). They constructed and analyzed the overall as well as the sectoral balance sheets of the United States over the period from 1900–80. Later, in the case of the United Kingdom, Revell (1966) presented a sovereign balance sheet for the period from 1957–61, and since 1975 such a financial statement has been published by the British government (Holder, 1998). In Canada, the official compilation of the sovereign balance sheet (in book value and market value) began in 1990. By now, most member countries of the Organization for Economic Cooperation and Development (OECD) have released at least a financial balance sheet.

China started a similar practice relatively late. Although in 1997 and 2007 the National Bureau of Statistics (NBS) published two reports presenting the methodology for compiling China’s balance sheet (NBS, 1997, 2007), no official report has yet been released. However, the balance sheet approach has long been used as a statistical tool within the national accounting system. Since the outbreak of crises in Latin America and Asia during the 1990s, the balance sheet approach has gained in popularity and use for macroeconomic analysis. Following the 2007 global financial turmoil, the balance sheet approach became a main analytical tool for scholars, governments, and international organizations. Some Chinese researchers such as Yi (2008) and Li (2009) have started to discuss China’s macroeconomic issues using the balance-sheet-approach perspective.

Compiling China’s Sovereign Balance Sheet: A Tentative Approach (2000–10)

This section discusses the approach to compiling sovereign balance sheets. Unlike the national balance sheet that covers both the private and public sectors, a sovereign balance sheet focuses only on the government and other state-backed institutions.1 In the case of China, it encompasses the government (central and local), state-owned financial institutions (including the central bank), and state-owned nonfinancial corporations. In other words, it directly reflects the government’s widely defined financial position and risk profile.

A clear structure of a balance sheet statement—assets, liabilities, and net worth—would be vital for the analysis. The assets refer to resources that are either in the government’s possession or under its control. Specifically, they include six items: business assets, nonbusiness assets, natural resource assets, foreign assets, the social security fund, and government deposits at the central bank. The sovereign liabilities include government debts and contingent liabilities due to implicit guarantees. They also include six items: central government debts (domestic and external), government-backed bonds, local government debts, debts of state-owned enterprises, contingent liabilities arising from nonperforming loans (NPLs), and implicit pension debts. Finally, the net worth of the government is defined as the difference between assets and liabilities.

Sovereign Assets

China has seen a significant buildup of sovereign assets, specifically the following:

  • State-owned business assets. The central and local governments hold stateowned business assets for commercial purposes. This includes state-owned assets of nonfinancial corporations and financial institutions. In 2010, the two subcategories of assets were RMB 59.1 trillion and RMB 8.2 trillion, respectively.
  • State-owned nonbusiness assets. These assets refer to financial and nonfinancial resources, which are generally held by administrative or public institutions. In China, such assets, amounting to RMB 7.8 trillion in 2010, constitute a major component of sovereign assets. Nonbusiness assets have some special characteristics. First, a large proportion of them are fixed assets (more than 40 percent in 2010). Second, they are mainly nonprofit-oriented and devoted to public services. These two characteristics imply low liquidity, indicating the inability of governments to use these assets to pay off debts in the normal course of operations. This is an important aspect to keep in mind when considering the analysis of the sovereign balance sheet presented later in this chapter.
  • State-owned natural resource assets. These include rural land, forest, subsoil, river, and sea assets. Due to data limitations, we only consider land resources. Drawing on a similar framework used by the World Bank (2006), this type of asset is valued at the net present value of the income derived from using rural land.2 Employing this method, China’s total value of land was estimated to be around RMB 44.3 trillion in 2010. That said, not all these assets are owned by governments (states). In fact, according to China’s Constitution (Article 10), land in the rural and suburban areas, which includes housing sites, private plots of cropland, and hilly land, is owned by collectives. Nevertheless, as stipulated in the Constitution, “the state may in the public interest take over the collective land for its use in accordance with the law.” Given that, the amount of RMB 44.3 trillion can be viewed as the maximum value of China’s land resources that the government is able to mobilize.
  • Foreign assets. These refer to reserve assets held by the government. China’s international investment position increased from US$618.6 billion in 2004 to US$2.9 trillion in 2010.
  • Social security fund. This fund is financed by the central budget or by transferring state-owned shares in the corporate sector with the second channel being double counted. Specifically, a part of these assets might have been considered as part of the state-owned business assets discussed above (especially during the transfer process).
  • Government deposits at the central bank. These assets refer to the deposits of central and local governments at the central bank. They include general budget deposits and government fund budget deposits. The deposits at the commercial banks are excluded here, but included in the item of “nonbusiness assets.”

A combination of the above items could illustrate the trend and composition of sovereign assets from 2000–10. Figure 4.1 shows that nonfinancial corporations’ state-owned assets and reserve assets have increased more rapidly than other items.

Figure 4.1Size and Composition of China’s Sovereign Assets

(In trillions of renminbi)

Source: Authors’ calculations.

Sovereign Liabilities

With heavy state involvement in different forms, the government has accumulated a significant amount of liabilities, as described below:

  • Domestic and external debts of the central government. These refer to debts the central government owes to domestic and foreign creditors. The external debts of the private sector (Chinese-funded and foreign-funded enterprises and financial institutions), for which the government might be responsible in the case of default, are also included in this subcategory. As shown in Table 4.1, in 2010 the domestic and external debts of China’s central government were RMB 6.7 trillion and 2.3 trillion, respectively.
  • Government-guaranteed bonds (quasi-government bonds). These refer to the bonds issued by various governmental departments and public institutions, including bonds issued by policy banks, which amounted to RMB 5.2 trillion in 2010. It should be emphasized that although the policy (noncommercial) banks do have some market-oriented securities, all their bonds are ultimately guaranteed by the government and thus considered sovereign debts.
  • Local government debts. These debts consist of two major parts. One is the debt from the LGFVs, including debt with explicit and implicit guarantee of the government. According to the China Banking Regulatory Commission, this type of debt was approximately RMB 9 trillion by the end of 2010. The other debt is from non-LGFV sources, whose debtors might be local governments and other local public institutions. The National Audit Office reports that these types of debts amounted to approximately RMB 5.7 trillion in 2010.
  • Debts of state-owned enterprises. Although they are independent corporate entities, state-owned enterprises (SOEs) should assume sole responsibility for their financial condition, although the government is the major investor (or shareholder) and may provide bailouts of last resort in the case of a crisis. Moreover, in this chapter necessary adjustments have been made to avoid double counting of local SOEs’ debts and debts due to LGFVs. As of the end of 2010, the debts held by the central and local SOEs were RMB 20.8 trillion and RMB 19.8 trillion, respectively.
  • Contingent liabilities due to NPLs. These liabilities refer to NPLs held by banks and other financial institutions (such as securities and insurance companies), which amounted to RMB 400 billion in 2010. Contingent liabilities may arise from indisposed NPLs. It is noteworthy that there are many ways to deal with NPLs, such as central government capital injection, issuance of special bonds, and central bank loans. Therefore, the NPLs were just transformed into different forms, but by no means did they disappear from the economic system. Such government-backed troubled assets, which were estimated to be RMB 4.2 trillion in 2010, are regarded as contingent liabilities in the sovereign balance sheet.
  • Underfunded pension liability. Because of commitments over time, a huge amount of implicit pension obligations (underfunded pensions) have accumulated. Given the absence of official data, this study uses the average value of various estimates offered by Chinese and international institutions, which was approximately RMB 3.5 trillion in 2010.
TABLE 4.1Sovereign Balance Sheet of China, 2010(In trillions of renminbi)
AssetsLiabilities and Net Worth of the

Deposits of government at central bank2.4Domestic debts of central government6.7
Reserve assets19.7Sovereign external debts2.3
Land assets44.3Local government debts (excluding LGFV)5.8
State-owned assets in administrative institutions7.8Debts from LGFVs9.0
State-owned assets in nonfinancial sector59.1Nonfinancial state-owned enterprises’ debts (excluding LGFVs)35.6
State-owned assets in financial sector8.2Policy banks’ debts5.2
State-owned assets in social security fund0.8Nonperforming loans0.4
Contingent liabilities due to NPLs4.2
Implicit pension debts3.5
Total assets142.3Total liabilities72.71
Net worth of the government69.6
Source: Authors’ calculations.Note: LGFV = local government financing vehicles; NPLs = nonperforming loans.

In this context, the sovereign-liabilities-to-GDP ratio reaches the level of 181 percent. But it should be noted that the liabilities are considered from a relatively broader perspective. If the state-owned enterprises’ debts (including debts from LGFVs) and implicit pension debts are deducted, the ratio lowers remarkably to 61.3 percent. If following the international norm and not considering the local governments’ debts, the ratio will be even lower.

Source: Authors’ calculations.Note: LGFV = local government financing vehicles; NPLs = nonperforming loans.

In this context, the sovereign-liabilities-to-GDP ratio reaches the level of 181 percent. But it should be noted that the liabilities are considered from a relatively broader perspective. If the state-owned enterprises’ debts (including debts from LGFVs) and implicit pension debts are deducted, the ratio lowers remarkably to 61.3 percent. If following the international norm and not considering the local governments’ debts, the ratio will be even lower.

A combination of the above items illustrates the trend and composition of sovereign liabilities from 2000–10 (Figure 4.2). Governmental debts (both central and local), SOEs’ debts, and contingent liabilities due to NPLs have increased more rapidly than other items.

Figure 4.2Size and Composition of China’s Sovereign Liabilities

(In trillions of renminbi)

Source: Authors’ calculations.

Results for China’s Sovereign Balance Sheet

After putting together the asset and liability profile, China’s sovereign balance sheet is shown in Figure 4.3. Over the past 11 years, both sovereign assets and liabilities have expanded considerably, but by different magnitudes. Sovereign assets expanded faster than liabilities and consequently net worth has been increasing.

Figure 4.3China’s Sovereign Assets, Liabilities, and Net Worth

(In trillions of renminbi)

Source: Authors’ calculations.

The risk of an imminent debt crisis in China thus appears to be negligible. Table 4.1 shows detailed data for 2010. Total net worth amounts to RMB 69.6 trillion (175 percent of GDP). Nevertheless, the poor liquidity of some types of assets makes it necessary to adjust the size of the estimated sovereign assets. Specifically, two changes are involved. First, state-owned nonbusiness assets are excluded because of their nonprofit administrative functions. Second, since the natural resource assets (e.g., land) are not entirely convertible to cash, we use annual land sale revenue in 2010 (known as tu di chu rang jin) to replace the RMB 44.3 trillion shown in Table 4.1. After these adjustments the amount decreases from RMB 142.3 trillion to RMB 93 trillion. As a consequence, net worth shrinks to around RMB 20 trillion. Despite the enormous difference between the two methods, net worth remains positive and thus China’s sovereign balance sheet seems to be resilient to a full-blown debt crisis. It indicates that Chinese authorities have sufficient financial resources to pay back all of the country’s debts, including contingent liabilities.

However, the above estimations should be interpreted with caution. First, several factors may underestimate the size. For instance, the change of land use (farmland to urban land) may not fully reflect market value, and some categories of assets remain denominated in book value rather than market value.3 Second, some assets, such as nonbusiness assets, cannot be easily liquidated. The calculations may also overestimate the value of the total assets.

On the liability side, the inclusion of contingent liabilities due to NPLs remains disputable. In reality, it depends on the loss-given-default probability of the NPLs. However, this analysis does not have sufficient information to estimate the exact size of losses, and so the entire NPL stock is taken as losses that could devolve on the government. Therefore, the sovereign liabilities may also be overestimated.

Overall Debt Level and Leverage Ratio in China

This section takes into account the debt level and leverage ratio of all main economic sectors, including households, nonfinancial corporations, financial institutions, and government (McKinsey Global Institute, 2010, 2012). The purpose is to better understand China’s overall financial risks by examining other interrelated contagion channels.4

Debts and liabilities differ from each other in several ways. Total debt consists of “all liabilities that are debt instruments” (IMF, 2011, p. 3). These include IMF Special Drawing Rights; currency and deposits; debt securities; loans; insurance, pension, and standardized guarantee schemes; and other accounts payable. Other liability items that “do not require the payment of principal and interest” (p. 3)—namely, equity, investment fund shares, financial derivatives, and employee stock options—are not considered debt.

Constrained by data, this section takes a narrow definition of debt by investigating two categories of liabilities: loans and bonds.5 The former constitute the major part of total debt in China, although the debt share of the latter has increased rapidly in recent years (Figure 4.4).

Figure 4.4China: Bonds and Loans

(Percent share of GDP)

Source: CEIC.

The debt structure varies in different sectors: for households, loans are the sole item on the liability side; nonfinancial corporations’ debts include both loans and corporate bonds; financial institutions’ debts are composed of policy-related financial bonds and other bonds; and government debts refer to the domestic and external debts held by the central government. For the purpose of international comparisons, local government debt is excluded from the analysis.6

Figure 4.5 shows the trends of overall and sectoral debt-to-GDP ratios for 1996–2010. As can be seen from the figure, the leverage ratio increased significantly during and immediately after the three macroeconomic shocks over this period: the Asian financial crisis of 1997–98, the bursting of the dot-com bubble in 2000, and the global financial tsunami in 2008. In this sense, the ratio can be a useful tool to analyze financial crises.

Figure 4.5China: Debt Level by Sector

(Percent share of GDP)

Sources: CEIC; and authors’ calculations.

International comparisons show that China’s debt-to-GDP ratio has been relatively low (Table 4.2). The total debt of all sectors accounts for 169 percent of GDP but remains low compared with other major developed economies. For example, the debt ratios of both Japan and the United Kingdom exceed 500 percent, and those for other countries are higher than 200 percent. There are, however, a few warning signs for China. First, China’s debt load appears heavier than those of major emerging countries. As reported in McKinsey Global Institute (2012), the debt-to-GDP ratios in 2010 for Brazil, India, and Russia were 148 percent, 122 percent, and 72 percent, respectively. Second, owing to the global financial crisis, China’s debt level has increased significantly in recent years. Third, as mentioned above, our analysis does not take into account local government debt, which represented around 20 percent of Chinese GDP in 2010 (a level similar to the debt level of the central government). These concerns suggest an accumulation of implicit financial risks and deserve attention.

TABLE 4.2International Comparison of China’s Debt Structure and Overall Leverage Ratio(Percent of GDP)


Corporation Debt

Institution Debt


United Kingdom9810921981507
United States87724080279
Sources: China’s data come from authors’ calculation and refer to 2010. Data for other countries are from McKinsey Global Institute (2012) and refer to the second quarter of 2011 (except for Italy, which refer to the first quarter of 2011).
Sources: China’s data come from authors’ calculation and refer to 2010. Data for other countries are from McKinsey Global Institute (2012) and refer to the second quarter of 2011 (except for Italy, which refer to the first quarter of 2011).

Debt also varies in different sectors (Table 4.2). The debt burden of China’s nonfinancial corporation sector is heavy, but the burden of the household and financial institution sectors is relatively low. To a large degree, this phenomenon reflects the characteristics of China’s current development pattern and financial structure. In fact, despite some positive changes over the past year (as direct capital-market-based financing has gained importance), the enterprise sector still relies heavily on indirect financing. As a consequence, loans remain the major liabilities of enterprises. If economic growth is robust, such a financing pattern benefits from relatively lower cost and risk. Nevertheless, in the event of declining growth, the troubles of nonfinancial corporations can easily spread to the financial sector through defaulted loans.

There are two caveats to this analysis. First, by no means do we suggest that the optimal debt-to-GDP ratio is zero. Under certain circumstances, a low debt burden might lead to inefficient allocation of financial resources. In theory, there should be a certain critical point at which the benefit-risk balance can be achieved. Such an intuition is supported by a recent study by Cecchetti, Mohanty, and Zampolli (2011). Using data from flow of funds accounts for 18 OECD countries, the authors find that the threshold debt level (still as a share of GDP) is 85 percent for the government and households and 90 percent for nonfinancial corporations. As shown in the table, this differs sharply from China.

The second caveat is the fact that various sectors are closely interrelated complicates the analysis. It is misleading to draw conclusions by focusing on a single sector. McKinsey Global Institute (2010) presents a good example: in 1995, the debt-to-GDP ratio was 148 percent for the Japanese nonfinancial corporation sector. However, it steadily declined, and by 2005 the ratio had decreased to 91 percent. Despite this deleveraging process, concerns remained regarding Japan’s macrofinancial stability because during 1995–2005 the country’s public-debt-to-GDP ratio soared from 84 to 180 percent, mainly due to the transmission of debt loads between sectors. Therefore, both overall and sectoral analyses are needed to understand the macrofinancial and financial stability interconnections.

Expansion of China’s National Balance Sheet

From 2000–10, China’s national balance sheet expanded substantially. On the asset side, three categories of assets saw a significant increase: foreign assets, infrastructure assets, and housing assets. The expansion reflects the fact that China has experienced accelerated industrialization and urbanization over the past decade. By following the export-oriented industrialization strategy, China has become the manufacturing center of the world, and accordingly runs large trade surpluses. As a consequence, vast amounts of foreign assets have been accumulated (mainly denominated in U.S. dollars). By the end of 2011, China’s foreign exchange reserves amounted to US$3.3 trillion, about 20 times as large as in 2000. However, as the urbanization process accelerates, investment in urban infrastructure needs to expand rapidly—and in fact it has, growing by an average rate of 18.4 percent per year (3.57 times over in real terms) during the period from 2000–10. Such investment has exceeded 10 percent of GDP in several years and has been as high as 15 percent in 2009 and 2010. Meanwhile, this process has created a boom in the urban housing market. According to our estimates, the total value of residential assets in urban areas was RMB 71.9 trillion in 2010, approximately seven times as large as in 1998.

Similarly, the liabilities of government and SOEs expanded more significantly than those in the private sector. To a certain degree, this trend reflects the characteristic of an “investment-driven” government, as the government still plays a crucial role in making large-scale investment decisions and tends to intervene in microlevel activities (sometimes even getting involved in the production process). This is especially the case at the local level. To boost local growth, and to finance various large-scale projects, the local governments commonly rely on off-budget mechanisms, such as the LGFVs. The latter are mainly dedicated to municipal construction, transportation facilities, and land purchase and reserve. Moreover, in parallel with heavy direct interventions in the market, China has had to provide explicit or implicit guarantees for the contingent liabilities owed by other sectors, including NPLs and pension debts.

Assessing Financial Risks

Conventional wisdom suggests that the sovereign balance sheet is exposed to insolvency and structural risks. The first kind of risk relates to the long-term fiscal capacity and economic growth prospects. This section focuses on risks of a structural nature. These consist of the following three categories of mismatches found on China’s sovereign balance sheet, all of which can lead to liquidity risk:

  • (1) Currency mismatch risk. China is holding a huge amount of official reserve assets that are exposed to the volatility of exchange rates. It is clear that China will suffer losses, at least in book value terms, due to the depreciation of foreign currency, especially the U.S. dollar.
  • (2) Maturity mismatch risk. China’s urbanization is mainly supported by long-term investment. Commercial banks often encounter the problem of mismatches between long-term loans and short-term debts (i.e., sources of funds, which are mainly in the form of deposits). Local governments are also commonly confronted with the mismatch between debt maturity and cash flows.
  • (3) Capital structure mismatch risk. This refers to a situation in which financing is overly dependent on liabilities, and consequently the equity share is relatively small. An international comparison shows that the total debt of China’s nonfinancial corporations accounts for 62.4 percent of the nation’s overall debt, which is 30 to 40 percent higher than the share of nonfinancial corporation debt in the sample of countries. Such a high debt burden and leverage ratio reflects the inherent vulnerability of China’s financial system, which is characterized by the dominance of the banking sector and indirect financing.

Based on various indicators, the direct risk exposure of the banking sector to housing finance is manageable. However, given factors such as the high mortgage-loan ratio in the banking sector, the close downward and upward linkage of the housing industry to other industries, and the overdependence of LGFVs on land sale revenue, banks’ indirect risk exposure to the housing sector could be large if the housing market were to undergo a severe negative shock. It should also be noted that although China’s overall housing-value-to-GDP ratio remains quite low—compared to household disposable income—urban housing prices appear to be higher in China than in some developed countries. China, thus, must guard against a possible scenario of a housing price boom.

Economic transition and population aging may add to the rapid accumulation of underfunded pensions. The current deficit in the private accounts of pension funds is around RMB 1.4 trillion. This debt load will be further aggregated in view of the broadening coverage of the pension system (especially covering urban and rural residents who are not formally employed) and deficits in health care insurance and unemployment insurance. As a last resort for funding shortfalls, the Chinese authorities are increasingly concerned about contingent debts and the ever-increasing liabilities associated with longevity risk as people live longer.

The sovereign-dependent sectors may also suffer from potential contagion risk through the balance sheet channel. Because of the relationship between claims and liabilities, the sectoral balance sheets are interconnected. Despite the fact that the government can mobilize financial resources among sectors to deal with debt payment problems, the debt burden of the sovereign does not decline. For example, although the NPLs in the banking sector decreased from RMB 2.17 trillion in 2000 to RMB 430 billion in 2010, on the sovereign balance sheet the contingent liabilities arising from the NPL clean-up soared from RMB 1.4 trillion to RMB 4.2 trillion. It is believed that to a large extent, the bad assets of the banking sector have been transferred from that sector to the sovereign.

Regarding the sustainability of the government debt burden, our scenario analysis shows that the development path of the government debt-to-GDP ratio is ultimately determined by the gap between the economic growth rate and the interest rate. From a macroeconomic perspective, if this gap remains sufficiently large, the government debt burden will stay at a low and sustainable level and thus the related risks seem small at present.

Conclusions and Policy Recommendations

Examining China’s national balance sheet in general and sovereign balance sheet in particular leads to drawing several preliminary conclusions. First, during 2000–10, China’s sovereign balance sheet expanded substantially. This trend can be explained by the accelerated industrialization and urbanization on the asset side and the government-dominated development model on the liability side.

Second, the narrowly defined net sovereign assets (assets minus liabilities) remain positive. This indicates that the Chinese government has sufficient financial resources to cover its debts. Therefore, the general risk exposure of China’s sovereign balance sheet is manageable, and the possibility of a near-term sovereign debt crisis in China seems negligible.

Third, the immediate risks in China’s sovereign balance sheet lie in housing finance and local government debts. In the medium to long term, the risks may mainly come from the external sector, corporate debts, and underfunded pensions. It should be noted that most of these risks can be viewed as contingent debts and are closely related to China’s growth model.

Fourth, the analysis of both the overall debt level and the debt-to-GDP ratio shows that while China’s debt load appears higher than those of other emerging countries, its general debt burden is still mild and manageable. However, there are several noteworthy and cautionary trends:

  • In 2010, total corporate debt in China exceeded GDP, and the corporate-debt-to-GDP ratio was higher than the generally observed threshold of 90 percent for OECD countries.
  • The household debt load is relatively low and thus has a large amount of room to increase in the future.
  • As demonstrated by international experience, as China’s economy enters into a more advanced development stage, the government will likely change its functions, and consequently its net wealth will tend to shrink or even become negative.
  • Scenario analysis shows that the gap between the economic growth rate and the interest rate determines the sustainability and risks of the debt burden.

Based on the above risk assessment, a change in China’s growth model appears essential in order to cope with the sovereign balance sheet risks. Policy recommendations toward that end include the following:

  • Currency mismatch risk needs to be lowered. China should slow its accumulation of foreign exchange reserves by boosting domestic demand and weakening its dependence on external demand. Meanwhile, China should promote international use of renminbi and encourage private agents to keep foreign assets and invest overseas. More importantly, given that the creditor currency mismatch cannot be resolved in the short term, China should actively employ the sovereign wealth fund mechanism to reduce the currency mismatch risk.
  • Financial stability risks of local governments need to be controlled, especially as they relate to maturity mismatch problems. Government interventions in microlevel economic activities should be limited. To promote market-oriented reform and the transformation of government’s role, the debtor entity’s responsibilities should be better defined and diversified. Meanwhile, the central and local government fiscal relationship needs to be redefined, and alternative financing channels through the private sector should be used more to support urban and infrastructure development.
  • To improve the structure of capital, China needs to further financial reforms to encourage the corporate sector to rely on equity financing rather than debt financing. This will help reduce China’s overall debt leverage.
  • To deal with the funding gap in the pension system, China should adjust its income distribution policies and deepen the reform of SOEs. In particular, mobilizing more profits from these enterprises and pushing ahead the process of reducing state-owned shares could be some of the alternative solutions.

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In some cases, the state-backed institutions are defined by the government.


The main difference between the current study and the World Bank (2006) study is that we use gross agricultural output value, while the World Bank separately also measures timber resources, nontimber resources, cropland, pastureland, and protected areas. For 2000, however, the results based on these two methods are similar.


Shen and Fan (2012) show that for the listed companies, the state-owned assets are underestimated if the book value is used in lieu of market value.


The transformation from NPLs to government’s contingent liabilities serves as an example of financial risk contagion from the private to the public sector.


In fact, we do not take into account other debt securities such as promissory notes, commercial paper, and transferable loans. See IMF (2011) for a detailed discussion of debt securities.


According to IMF (2011), local debts are not considered government debts, partly because in many countries the central government is not responsible for the budgets of local governments.

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