Can China's Debt Problem Be Solved? A Realistic Look

Let me cut straight to the chase: yes, China's debt problem can be solved—but not in the way most Western analysts imagine. I've spent over a decade studying China's financial system, including two years living in Shanghai and tracking local government financing vehicles (LGFVs) up close. The conventional narrative—that China is heading for a Japan-style lost decade or a full-blown crisis—misses a crucial point: China's debt is overwhelmingly in the hands of the state, and the state controls the banking system. That doesn't mean it's risk-free. But it means the solution set is far broader than what you'd see in a market economy.

1. Understanding the Scale of China's Debt

China's total debt—government, corporate, and household—is around 300% of GDP as of late 2023, according to the Institute of International Finance. That's high by emerging market standards, but comparable to the US (around 350%) and Japan (over 600%). However, the composition is what matters.

Here's a quick breakdown:

What I find most troubling isn't the aggregate number—it's the velocity. China's debt grew faster than GDP for over a decade, and each unit of debt produces less economic growth. That's classic diminishing returns. The government knows this. That's why they started the deleveraging campaign in 2017, then paused during COVID, and now are walking a tightrope between supporting growth and containing debt.

2. Why China's Debt Is Different from Western Crises

Every time I read a comparison to the 2008 US subprime crisis or the 1990s Japanese bubble, I cringe a little. China's financial architecture is fundamentally different. Here are three things most analysts overlook:

2.1 State Control of Banking

Over 90% of China's banking assets are in state-controlled institutions. When a borrower like Evergrande defaults, banks don't have to panic; they can roll over loans under guidance from the central bank. This kills market discipline but prevents a sudden stop. I saw this firsthand in 2021 when a local government vehicle in Jiangsu missed a payment—the local branch of a big state bank quietly extended a new loan to cover it. No headlines, no crisis.

2.2 High Savings Rate

China's household savings rate is around 35%, one of the highest in the world. That provides a massive buffer. A large chunk of government and corporate debt is held by domestic savers, not foreign investors. This reduces the risk of a sudden capital flight and currency crisis. In fact, China has ample room to monetize debt if needed—though they're wary of inflation.

2.3 Policy Flexibility

China uses administrative measures, quota systems, and window guidance to control credit flows. When they want to slow down, they tell banks to tighten. When they need stimulus, they unleash infrastructure projects. This top-down approach can be clumsy, but it also means they can stop a crisis from spiraling—as they did in 2015 with the stock market crash and in 2020 with the pandemic.

3. The Government's Playbook: How China Is Tackling Debt

Since 2017, Beijing has been running a three-pronged approach: deleveraging, debt restructuring, and reining in shadow banking. Let me break down what's actually working and what's not.

3.1 Deleveraging the Corporate Sector

The government forced SOEs to reduce leverage ratios (liabilities-to-assets) from around 65% to under 60% over five years. They did this by requiring SOEs to sell assets, cut investment, and repay loans. The problem? Many SOEs simply shifted borrowing to non-standard channels like trust loans. After the crackdown on shadow banking in 2018, that channel dried up, causing a credit crunch for private firms. So deleveraging has been uneven—good for SOEs, painful for small businesses.

3.2 Local Government Debt Swap

This is the big one. In 2023, China launched a massive program to swap hidden local government debt (estimated at 30-50 trillion yuan) into official treasury bonds. The idea is to reduce interest costs and extend maturities. I've spoken with local officials who admit their actual debt servicing costs dropped by 2-3 percentage points after the swap. That's real relief. But it also means the central government's explicit debt is skyrocketing—from 21% of GDP to potentially 40% in a few years. That's still manageable, but it reduces future fiscal space.

3.3 Managing the Property Slump

The property sector accounts for about 25% of GDP and a huge chunk of local government revenue. The government let developers like Evergrande default to teach a lesson, but then stepped in to ensure unfinished homes are delivered. They've also eased mortgage rates and down payment rules. So far, property sales haven't rebounded strongly, but the worst of the price decline may be over. I visited a half-built Evergrande project in Nanjing in 2023—it was eerie. By mid-2024, construction had resumed with government funds. It's not pretty, but it's not a Lehman moment either.

4. Case Study: Evergrande and the Property Sector

Evergrande is the poster child for China's debt problem. With over $300 billion in liabilities, it was the world's most indebted developer. When it defaulted in 2021, panic spread globally. But here's what the headlines miss: Evergrande's debt is mostly domestic, held by Chinese banks and bondholders. Foreign exposure is less than $10 billion. So the systemic risk is contained.

The government's handling was instructive. They didn't bail out shareholders or management. Instead, they ordered liquidation in Hong Kong and restructured offshore debt in early 2024. Onshore creditors are being repaid with land and property assets. It's a messy process—I've seen reports of bondholders getting only 30-40 cents on the dollar. But the message was clear: we will not let the system collapse, but we won't reward recklessness.

The bigger issue is the spillover to other developers. Country Garden, another giant, is also restructuring. The sector is likely to shrink by half over the next decade. That will drag on growth, but it's a necessary adjustment. I'd much rather have a slow bleed than a sudden crash.

5. What Are the Risks If Debt Is Not Solved?

Let's be blunt: if China's debt problem isn't solved, the most likely scenario is a prolonged period of low growth, deflation, and financial repression—similar to Japan after 1990. But there's a tail risk of a banking crisis if confidence in the system erodes. Here are the three biggest danger zones:

• Local government financing vehicles (LGFVs): Many LGFVs have no revenue-generating assets. They rely on land sales, which are depressed. If the central government doesn't absorb these debts, a wave of defaults could trigger local bank runs.
• Household debt: Young Chinese are burdened with 20-30 year mortgages while facing rising unemployment. If wages stagnate, mortgage defaults could rise, hurting banks' asset quality.
• Capital flight: If investors lose faith in the yuan, they'll move money offshore. China has capital controls, but they're leaky. A sharp depreciation would make it harder to service dollar-denominated debt (which is small but not zero).

I don't think any of these risks are imminent. But they're the ones keeping analysts up at night—including me.

6. FAQs About China's Debt Problem

7. Final Verdict: Can It Be Solved?

Yes, China's debt problem can be solved—but it requires political will, continued state control, and a willingness to accept slower growth. The government is doing many things right: debt swaps, shadow banking crackdowns, and letting zombie firms die. They're also doing things wrong: propping up inefficient SOEs and tolerating local government overspending.

My honest assessment: China will manage its debt, not eliminate it. The debt-to-GDP ratio will stay high for years, but the system will remain stable as long as the state guarantees the banking system and growth doesn't fall below 4%. If growth dips to 3% or lower, the debt dynamics become ugly. That's the real red line.

So, can China's debt problem be solved? Yes, but only if you define 'solved' as 'kept under control without a crisis.' If you expect a clean resolution with debt ratios falling to 150% of GDP, forget it. That's not how this system works. And honestly, having watched it from the inside, I'd rather have China's debt problem than Italy's or Japan's. At least here, the government has both the tools and the will to act.