One research firm, Gavekal Dragonomics, calls it “the magical debt-shrinking machine”. When the Chinese government first confronted a mountain of non-performing loans in the state-owned banking sector it came up with a seemingly ingenious solution. Rather than write off NPLs totalling Rmb1.4tn ($216bn), or almost 20 per cent of gross domestic product in 1999, specially created asset management companies bought them off the country’s big four state banks at full face value, paying with government-backed 10-year bonds. When the bonds came due in 2009, after a decade of rapid growth, the NPLs purchased 10 years earlier were worth less than 5 per cent of GDP, in theory making them easier to write off.
As Beijing confronts increasing scepticism about the country’s high debt-to-GDP ratio the hunt is on for another magical debt-shrinking machine. There is, however, much evidence to suggest that the first miracle machine only helped China avoid a potential debt crisis 20 years ago by postponing it — to today.