China urgently needs a plan to address a build-up of corporatedebt that is manageable but with a window to address it “closingquickly,” according to an International Monetary Fund workingpaper.

The rapid increase of debt since the global financial crisis hasleft China with a credit gap comparable with those experiencedpreviously by countries such as Thailand, Spain and Japan thatsubsequently experienced “painful deleveraging,” said the paper byIMF staffers. China's risks appear high but are manageable if theproblem is addressed promptly, it said.

The working paper's warning adds to a drumbeat of concern over asurge in corporate debt that coincides with dwindling economicreturns as the nation gets less growth for each buck of credit.China's government released guidelines last week for reducing debtand said it won't bear final responsibility for borrowing bycompanies.

“International experiences suggest that credit booms of thissize increase the risk of slower growth or a disruptiveadjustment,” said the IMF staffers. “The authorities recognize theproblem, but appear to be still searching for a comprehensive,proactive, strategy.”

Potential Losses

Potential debt at risk is estimated to be about 15.5% of thetotal corporate loan portfolio as of end-2015, which could yieldestimated potential losses of about 7% of GDP, the authorsconclude. The IMF staff estimate that exiting from loss-makingfirms would cost 7.8 million jobs — 2.8 million in overcapacitysectors like coal and steel and 5 million in construction.

Cuts to overcapacity would likely take time and displacedworkers will be gradually absorbed into new sectors, the authorssaid. The net impact on GDP of sector consolidation is estimated tobe a loss of 0.6% in the first year, 0.2% in the second, close tozero in the third and a boost of 0.2% in the fourth, the paperestimated.

China's total debt grew 465% over the past decade, according toBloomberg Intelligence. Total debt rose to 247% of gross domesticproduct in 2015, from 160% in 2005, with corporate debt jumping to165% of GDP from 105%.

The corporate debt problem should be addressed urgently with acomprehensive strategy, the paper said. That should includeidentifying companies in financial difficulties, proactivelyrecognizing losses in the financial system, burden sharing,corporate restructuring and governance reform, hardening budgetconstraints and facilitating market entry, the authors said.

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