China's economic stability is founded on a mountain of debt that Council on Foreign Relations experts warn will end in a crisis.

The country's total non-financial sector debt, which includes household, corporate and government debt, will surge to nearly 300% of GDP by 2022, up from 242% in 2016.

By some estimates, China’s true growth rate after taking the bad debt into account could be just half the official 6.9%.



China’s worrisome build-up of corporate and household debt is well-documented, but fears of a financial crisis have receded sharply from the turbulent days of 2015 and 2016, when the country’s stock market crashed on fears that an epic two-decade growth streak might come to an abrupt halt.

Since then, a proactive Chinese government and stronger-than-expected global economic growth have supported China’s economy and eased fears about a sharp imminent slowdown. Still, concerns about the country’s debt levels have only deepened.

"In the short-run, growth, as defined by changes in gross domestic product (GDP), can be increased by more lending and investing," write Benn Steil and Benjamin Della Rocca of the Council of Foreign Relations in a new blogpost.

"In the longer-term, however, lending and investing can’t boost GDP if it results in bad debt that is properly written down. The big question is how much bad debt China currently has, and how much more it will be producing in the years ahead."

By some estimates, they add, China’s true growth rate, after taking the bad debt into account, is barely half the reported 6.9% clip. The country's total non-financial sector debt, which includes household, corporate and government debt, will surge to nearly 300% of GDP by 2022, up from 242% in 2016.

Steil and Della Rocca examine recipients of the recent wave of lending to "gauge whether China has been creating good debt—debt that will produce positive returns—or bad."

They find that profits at private-sector firms rose 18% between 2011 and 2016, while profits at state-owned enterprises that are far less efficient plunged 33%. At the same time, the share of corporate liability growth accounted for by the state sector soared from 59% in 2010 to 80% by 2016, as the chart below shows, a terrible omen for productivity.

"Given the evidence that President Xi Jinping has abandoned any pretense of concern with NPLs, and our evidence that China is shoveling new loans to companies with the least ability to pay them back, we think China is heading towards a debt crisis," Steil and Della Rocca warn.