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By Adorno Auguste

Correcting China’s Current Debt Levels

Dec. 23, 2016  |     |  0 comments

The 1997-98 economic crisis in Korea and Taiwan demonstrated to the world how important government policy can be in managing economic dilemmas that involve debt problems. There is evidence that China is currently facing the same problems encountered by Korea and Taiwan during the 1997-98 Asian crisis. China must learn from the examples of Taiwan and Korea by understanding what strategies they implemented to overcome the Asian crisis of the 1990s. Although there is very little consensus regarding whether China must implement the same strategies as Taiwan and Korea, the analysis can be very important as it holds significant implications for China and their economic stakeholders.

Toxic loans among China’s financial institutions are clearly a threat to economic growth. Data from the China Banking Regulatory Commission (CBRC) indicates that non-performing loans (NPLs) as well as the NPL ratio (defined as total NPLs over total loans) of the banking sector have increased steadily over 16 consecutive quarters, reaching RMB 1.186 trillion and 1.59 percent respectively at the end of September 2015. Between January and September of 2016, toxic loans rose by about RMB 343 billion, a figure which was greater than the total increase in NPLs (RMB 251 billion) experienced in the preceding year. In 2016, toxic loans at Chinese banks increased to RMB 4.6 trillion by the end of March. This figure is RMB 428 billion higher than the same figure just three months earlier. See Figures 1 and 2.

The drastic increases in China’s NPLs over a short period is like those experienced in Korea and Taiwan in the 90s. The situation in Korea and Taiwan forced them to apply austerity measures to reduce their overall debt while specifically targeting toxic loans for restructuring. Short-term loans were encouraged by the government of China, but banking institutions and business firms collected these loans and used them for long-term projects. This was one of the major reasons for the increase in toxic loans held by Chinese banks. Many economists think that China is currently suffering the same economic dilemma as Korea and Taiwan during the 1990s.

Figure 1. NPL Balance and NPL Ratio in Chinese Commercial Banks (in RMB billion)

Source: CBRC’s statistical reports

Following the global financial crisis of 2008, the government of China developed a far less stringent monetary policy, and RMB 4 trillion was pumped into the financial system as an economic stimulus. The stimulus program helped to boost the Chinese economy; however, Chinese debts increased rapidly as they were driven by real estate lending and shadow banking activities. By June of 2014, China’s debt to GDP ratio skyrocketed to 282 percent. Although this figure might seem considerable, it is important to note that it is higher than that of many developed nations such as Australia, the US, and Germany (274 percent, 269 percent and 258 percent respectively). China’s increasing debt level has placed additional pressure on the corporate sector regarding cash flows needed to service debt payments. In addition, the boom in speculative investments has overwhelmed many capital-intensive sectors that includes steel, cement, solar, shipbuilding, heavy machinery, and mining industries. This has forced China to turn NPLs into equity for players in these sectors.

Figure 2. NPLs and Special Mention Loans are Growing

Source: CBRC data, PwC analysis

China’s Present Condition

China was able to evade the serious economic consequences during the 2008 international economic recession. China started a campaign aimed at improving state-directed spending. This measure drastically increased their debt. Although this guarded China against the global crisis, critics argue that the financial crisis was only delayed for China. Today, the debt of China continues to increase. In the first quarter of 2016, China’s total debt increased to a record level of 237 percent of GDP. This is beyond other emerging-market by comparison, which reveals the depth of the problem that exists in China. This also increases the likelihood of plunging into slowed economic growth or a significant recession (Wildau & Weinland, 2016). Beijing has resorted to large-scale credit lending as a source of economic growth; hence their net debt is now forecasted to total RMB 163 trillion by the end of March of 2017. Such debt levels are extremely dangerous as it is far greater as a percentage of GDP when compared to other developing economies (Wildau & Weinland, 2016). The debt level of China is a major concern; however, what is more worrying is the pace at which China has accumulated such large debts. At the end of 2007, China had a debt that was just 148 percent of GDP, but now it is in the region of 249 percent of GDP. This level of debt is only comparable to that of the Eurozone (270 percent) and United States (248 percent). According to the Goldman Sachs Chief Investment Strategist, Ha Jiming, every country that has experienced a drastic increase in the level of debt has also been caught up in a prolonged economic slowdown or a financial crisis (Wildau & Weinland, 2016).

Beijing is managing the way they spend to support short-term growth. In a bid to defend against financial risk in the long-run, Chinese banks are deleveraging. Currently, China has implemented a stimulus program to decrease market fears of an upcoming economic crash. Per data from Central Bank and FT calculations, Beijing has increased its debt by RMB 6.2 trillion in only three months (Wildau & Weinland, 2016). While almost every economist agrees that the economy’s health is at risk, there is division on what the outcome will be. Some economists liken the situation to that of the United States in which there was a serious financial crisis, while others liken it to Japan which had slow economic growth for decades (Wildau & Weinland, 2016). It is speculated that with time some banks in China will become unable to safely fund their entire assets. If this prediction is true, China is most likely to experience a financial crisis defined by toxic debt and constrained cash flows that are unable to meet immediate debt payments.

Zhang and Miller (2016) summarized the condition of China by showing how China has increased toxic non-performing debt over an 18-quarter period. It is even argued that the reported level of NPLs is lower than the actual level (Zhang & Miller, 2016). There has also been an upsurge in crisis lending at commercial banks in China, with such lending reaching USD 706 billion in March. This accounts for a RMB 428 billion increase from December of 2016. Because of China’s economic slowdown, the speed at which loans are becoming toxic has also grown. Per China Banking Regulatory Commission, NPLs among Chinese commercial banks rose to RMB 1.4 trillion, which is said to be the highest it has ever reached in 11 years (Zhang & Miller, 2016). This is a great threat that requires corrective action.

Causes of the Financial Crisis in South Korea and Taiwan

By 1991, South Korea was running at USD 8.7 billion deficit, which was more than four times the deficit of the previous year (Kim, 2006). For financing the increasing deficit, the government encouraged capital inflows. In a bid to accomplish this objective, there was acceleration of capital injections made by the government. In 1991, more capital stimulus was made possible by the Foreign Exchange Management Act (Kim, 2006).

In 1993, a plan was drafted by the South Korean government for the liberalization of the financial sector that aimed at deregulating assets and improved governance at financial institutions. Once again, the government did not take into consideration the need for the regulation to be pragmatic. The results included a rise in foreign currency debts of banks and other financial institutions (Kim, 2006). In 1996, the government further implemented more stimulus packages and financial deregulations to join the OECD. However, it was the decision of the government to only relax immediate rather than long-standing capital inflows (Park, Song, & Wang, 2004). Although these short-term financing loans were collected by business firms and financial institutions, they were invested on long-term projects. This resulted in an increase in short-term external debt, which was up 61 percent in 1996 (Kim, 2006).

Another issue that led to the financial crisis in South Korea was the demise of the Hanbo group. The Hanbo group had serious financial problems and called for a financial bailout from the government, which refused to grant the bailout to the Hanbo group (Kim, 2006). Furthermore, the South Korean public sector had very limited resources to finance chaebols having financial problems. The result of this was bankruptcy for big chaebols such as Jinro, Sammi, Hanbo, and many others (Kim, 2006). Even in the case of Kia, the government failed to come to a decision to provide bailout funds, which led many foreign investors to hold their investments or take their investments elsewhere (Kim, 2006). Furthermore, a combination of domestic and international developments also triggered a financial crisis in 1997. More foreign investors left South Korea, and on November 21, the government was forced to request aid from the International Monetary Fund (IMF) (Kim, 2006).

Apart from the damage caused by asset bubbles in land prices and equity, Taiwanese banks had to adjust to rapid financial liberalization.

Just like in the case of South Korea, Taiwan’s financial crisis can be attributed to two factors: macroeconomic conditions and financial liberalization. Asset prices increased drastically in the late 1980s, and the price of houses increased more than four times in a period of three years between 1987-90. In July 1985, the Taiwan Stock Exchange was 6,537 points. Only five years later it had increased to 12,054 points. The market started to crash after hitting the peak, and by September of 2009 it has already hit a low of 705 points. Since then, the Taiwan market has been tremendously unstable. The deterioration of real estate and equity prices had a great impact on the banking sector. Banks provided loans to many debtors when real estate prices were high. By March of 1980, individual loans constituted 20 percent of total loans collected from banks. Ten years later this figure increased to more than two times its initial level. This resulted in individual loans making up 44 percent of NPLs held by Taiwan banks (Yin, 2001). Banks used real estate as collateral during this period, and this caused the value of real estate to plummet. Equity prices fell and this impacted the capital stock held among institutional banks.

Another major cause of the financial crisis in the banking sector of Taiwan can be attributed to financial liberalization. Apart from the damage caused by asset bubbles in land prices and equity, Taiwanese banks had no choice but to adjust to an environment that was rapidly changing due to financial liberalization. After the securities transaction law was revised in 1988, the number of banks increased from 163 to around 600. In the mid-1990s, financing of corporate bonds became a tremendous source of competitive advantage among banks. By 1997, corporate bonds accounted for 32 percent of long-term debt, which was a 27 percent increase from 1991 levels (Ding & Yeh, 2001). The liberalization also caused private enterprises to rely less on indirect financing from banking institutions. Privatization of the banking sector increased the number of new entrants in the banking sector, and 15 new banks started operation in June 1991 (Yu, 1999). New privately-owned banks performed better than the older banks owned by the government, as evidenced by their significantly lower NPL ratios. However, the situation reversed when the banking sector started to decline. NPL ratios for the new banks began to increase, and even surpassed those of the old banks. This means that the return on assets ratios were already negative. Yin (2001) suggests that the crisis in the banking sector of Taiwan occurred because the expansion of the banking sector was not accompanied by adequate supervisory resources. Therefore, the quality and frequency of strategic leadership and planning suffered.

South Korean and Taiwanese Debt Policy During the Crisis of 1997-98

In 1997, the share of NPLs among total loans in South Korea reached 7.4 percent and rose to more than 8.3 percent in 1998. For the 30 biggest conglomerates, debt-to-equity ratios surpassed 500 percent in 1997 (Spilimbergo et al., 2008). Depreciating currency associated with high interest rates pushed many corporations and most of the banks to the edge of soundness. The ratio of interest coverage in manufacturing reduced from 12.9 to 68.3 between 1997 and 1998, and further increased in 1999 to 96.1, as compared to the United States ratio of 354.0 and the Japanese ratio of 367.5 (Iwulska, 2012).

The South Korean authorities’ response was quick enough to tackle the rising problems. First, companies’ balance sheets became the focus of private debt restructuring. The restructuring program included foreign investments, debt/equity swaps, equity injections, and asset sales. In this period, debt/equity swaps proved to be extremely useful. Second, the focus of policy shifted to the underlying problems in the banking system. The authorities used most of their resources to restore the health of the corporate and financial sector rather than fiscally stimulating demand. Banks were either liquidated, merged, or recapitalized. To handle bad loans, a special institute was created: the Korea Asset Management Corporation. Finally, South Korea moved from a financial system incapable of permitting default to one capable of allowing companies to go bust. This led to the closure of five of thirty-three banks in 1998. Regimes that allow for bankruptcy seem to have better economic results than state-directed regimes (Cargill and Parker, 2002). The process of restructuring could be successful only with the changes in the regulatory framework.

Although Taiwan was also hit by the 1997 financial crisis, their experience was not as extreme as those of the other neighboring Asian economies. Taiwan was the least hit of all the countries, and did remarkably well in weathering the crisis. One interesting point during the period of 1997 and 1998 was that its NPL ratio was below 3%. However, when other countries in Asia were recovering from the crisis, the financial strength and health of Taiwan went in the reverse direction. The combined rate of depreciation of Taiwan’s currency against the dollar and the decline in stock prices dipped 24 percent. Taiwan was not so hard hit by the financial crisis of 1997 because of some discreet policies that were in place before the inception of the crisis. Some of these policies such as the upgrading of industries, financial liberalization, tariff reduction, and import controls relaxation led to improvements in productivity and the financial system. Furthermore, they helped with the expansion of the exports industries that were technologically-driven. Upgrades to Taiwan’s industries and improvements to increase their competitiveness in global markets helped Taiwan to survive the crisis. Additionally, several restructuring and liberalizing measures that were created and implemented by Taiwan prior to the 1990s also played an important role in the establishment of an economic system capable of withstanding external shocks resulting from the Asian financial crisis.

Chinese Adaptation of Similar Policies

For Chinese lenders, the 18 percent increase of toxic debt that followed the state-driven credit boom of 2009 has shown no sign of immediate improvement (Bulloch, 2016). This is driving authorities to use unconventional measures that can potentially prevent a future debt crisis. Six banks were given a total of RMB 50 billion to issue securities with NPLs as underlying assets. Authorities are also preparing to introduce debt-to-equity swaps, which is a measure that could save banks from NPLs from the early 2000s. The general strategy will be to convert loans into shareholdings. The debt-to-equity initiative is one of the schemes designed to clear bad loans by bundling and selling the weak assets. The IMF recently published some “technical notes” on this initiative, noting that NPL-to-Equity schemes can play a role in resolving problems of excessive debt, subject to certain provisions. The IMF also repeated its assessment that the NPL problem was “manageable, but must not be allowed to get out of hand.” This demonstrates the importance of acting quickly to mitigate the threats associated with China’s growing debt problem.

China is also loosening restrictions on the way local governments dispose of bad loans, opening new avenues that may speed up disposal but may also obscure the country’s ability to write off a soaring volume of corporate debt (Yap, 2016). Using the new policies, provincial governments will be able to set up bad-loan management companies that are owned locally. They will also be able to limit the geographic reach of firms that are selling bad loans. During the previous 17 years, toxic NPLs have become a rapidly developing business opportunity. In 1999, China set up four asset-management companies to handle an earlier debt problem. The government had planned to retire these firms in a decade, but a new round of unprofitable investment during last seven years made them active again. NPLs increased to such levels that these four nationwide asset-managers now have local competition.

The success of China’s economic initiatives will rely upon how effective the government can be in terms of implementing stimulus policies.

Huh and Yoo (2002) suggested that in a bid to solve the crisis, the South Korean government set preconditions that had to be satisfied before bail-out funds were provided, including austerity policies dependent on high rates of interest and fiscal retrenchment, the closure of insolvent financial institutions, the introduction of a robust supervision system, and the increase in the flexibility of the labor market. Furthermore, the financial institutions that survived were provided with public funds to increase their equity capital, which led to the nationalization of some large commercial banks, and the sale of others to foreign investors. Tight supervision was a key to the resurgence of the South Korean economy.

The actions taken by the Chinese government are identical to that taken by Taiwan and South Korea during the 1997 recession. First China has loosened its monetary measures. It first reduced the lending rates and the 12-month benchmark deposit from 7.47 percent to 5.31 percent and from 4.14 percent to 2.25 percent respectively (People’s Bank of China, 2008). Furthermore, the PBC lessened the number of operations in the open market and also reduced the reserve requirement ratio for large financial institutions as well as small financial institutions on four separate occasions. This helped in releasing about RMB 800 billion in liquidity and increased excess reserve to 5.11 percent (“Backgrounder: China’s”, 2009).


After decades of strong economic performance from South Korea and Taiwan, both of their economies were hit by a financial crisis. The economic recession that followed was the result of too much spending and too much debt. The crisis caused a significant slowdown of their economies. To successfully mitigate the crisis, both governments responded promptly with monetary policies that include a fiscal stimulus package. In recent years, China’s debt level has been increasing, along with toxic debts on the country’s balance sheet. The results experienced by China can be compared to the economic situation in Taiwan and South Korea before the financial crisis hit in the 1990s. This research study has provided an analysis on the economic crises in Taiwan, South Korea, and China. The findings have shown that China can mimic the strategies adopted previously by Taiwan and South Korea to overcome their debt crises and consequential recessions that followed. Specific reasoning has been provided that explains why South Korea and Taiwan were successful at managing their economic crises.

These results hold tremendous value for China because it provides a list of previously effective economic strategies. This means that China must strongly consider transferring the strategies implemented by Taiwan and South Korea to mitigate the threat of an economic recession stemming from deficit spending and growing debt. While China may have started to follow the debt management methodologies of South Korea and Taiwan, the success of their economic initiatives will rely upon how effective the government can be in terms of implementing stimulus policies. It is crucial for economies highly reliant on international trade to target exchange rate management strategies as they have proven to be successful when implementing new monetary policies. China is in a vulnerable position economically; however, evidence suggests that the country can adopt strategies to realize a very stable economy again. However, this means that Chinese officials must also ensure that the process is supported by evidence-based financial practices and guided by leaders with sufficient experience navigating China’s complex economic landscape.


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