Why China's Debt Bubble Won't Burst

Is China facing the prospect of a financial meltdown? That’s a question gaining new urgency as its economy decelerates: Growth in the second quarter came in at 7.5 percent, its second consecutive decline. Total debt now amounts to more than $17 trillion, or an astonishing 210 percent of gross domestic product, up 50 percentage points from four years ago, estimates Wang Tao, chief China economist at UBS Securities.

The scale of the problem suggests the worries are well founded. Take China’s highly leveraged corporate sector. Company debt reached 113 percent of GDP at the end of 2012, up from 86 percent in 2008, when the country’s leadership directed banks to open their lending spigots during the financial crisis, estimates Louis Kuijs, chief China economist at Royal Bank of Scotland in Hong Kong. Making matters worse, the biggest company borrowers—state-owned enterprises in heavy industries like steel, aluminum, solar, and ship-building—are now saddled with overcapacity funded by the easy credit.