In the past year alone, China’s corporate debt has risen from 108% to 122% of GDP, thus bringing the total debt up to 206% of GDP.

The problem with this is that majority of the companies and banks are state owned. Therefore, if companies were to default on their loans, it will really be the Chinese government who suffers along with its economy.

Additionally, this article brings to mind the 2008 rescission, which was primarily caused by the banks lending money to people who couldn’t afford a home, resulting in many homes being foreclosed. Now, it’s multiple firms who are now saddled with debt, and it’s just a matter of time before a couple of major firms default on their payments, which will cause a snowball effect. Firms will not be able to pay their debts because other firms who owe them money will not have paid them back yet. This will result in banks and firms being forced to write down billions of dollars in bad loans, in which case the government will pick up the bill, which would consequently bring the Chinese economy to a halt.

3 ways in which the Chinese government could limit its exposure include:

1) Changing banks and corporations from being state owned to privately owned, thus limiting any losses just to the corporate and financial entities and not to the government itself.

2) Slightly raising interest rates which will pressure firms to pay back loans.

3) Enforcing a stricter lending criteria.

References:

Roberts, Dexter. “Corporate China’s Black Hole of Debt.” Businessweek.com. BloombergBusinessweek, 15 Nov. 2012. Web. 15 Nov. 2012. <http://www.businessweek.com/articles/2012-11-15/corporate-chinas-black-hole-of-debt>.