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In this next episode of our series Rethinking Asia, we pick up where we left off last episode looking at the role of debt in China\\u2019s economy. We spoke with Charlene Chu, a senior partner for China macro-financial research at Autonomous Research, an independent research firm. Well known for her analysis of China\\u2019s shadow banking industry, Charlene previously was a senior director covering Chinese financial institutions at Fitch Ratings.

Charlene gave her assessment of the recent rise in Chinese debt and why she thinks a painless deleveraging is unlikely. While China has implemented some reforms in recent years, it has mostly avoided deleveraging. Previously, China relied on a high deposit base to support credit expansion, but new credit consistently outstrips deposit growth making the levels of credit growth unsustainable. Some of Charlene\\u2019s main takeaways include:\\xa0

• China\\u2019s debt-to-GDP has increased by nearly 150 percentage points since the Global Financial Crisis, accompanied by a $30 trillion increase in the banking sector. While other countries have experienced large increases in debt-to-GDP before, the size and scale of China\\u2019s economy makes the growth alarming.
• The vast majority of China\\u2019s debt is in the corporate and property sectors. China has also experienced a run up in consumer debt over the last few years, but, currently there is no concern in households\\u2019 ability to service the debt.
• One of the most troubling aspects of China\\u2019s debt problem is the surge in the more opaque and less regulated shadow banking sector. However, the merging of two regulatory bodies should reduce some of the regulatory arbitrage that has allowed off balance sheet lending to grow.
• While a financial crisis is not preordained, Charlene dismissed the prospects of a \\u201cbeautiful deleveraging.\\u201d Any attempts to deal with China\\u2019s debt burden will require hard decisions, including shuttering less productive companies by forcing them to realize losses, reining in shadow banking, capping credit growth, adjusting lending rates to account for risk, and accepting lower levels of GDP growth.

The views expressed are not necessarily those of the Federal Reserve Bank of San Francisco or of the Federal Reserve System.