China's debt-to-GDP ratio is at its highest ever level at almost 50% while its Q1 2019 economic growth slumped to multi-year lows at 6.4%, according to data from Trading Economics and the Bank for International Settlements, but many investment professionals warn against preparing for a hard landing or a banking crisis.
The issue has been thrust into the spotlight recently ahead of the inclusion of onshore Chinese renminbi-denominated government debt within the Bloomberg Barclays Global Aggregate index, of which it will represent around 5%, thereby increasing developed market investors' direct exposure to the country's debt markets.
Investors have been concerned about China for some time, following a collapse in the global demand for goods - including exports from China - during the throes of the 2008 Global Financial Crisis.
After exports plummeted and millions of factory workers lost their jobs, the Chinese government decided to fund fiscal policy through bank loans and ultra-loose monetary policy.
Billions of dollars of fiscal stimulus has helped accelerate GDP growth, which has been at least 6% per annum over the last decade. However, this has come at the cost of mounting debt with government liabilities at $5.3trn, or 46.7% of GDP, at time of writing.
While this is substantial, the consensus among fund managers investing in the country is that China's government has the right policy tools in place to reduce debt levels and mitigate the chances of a full-blown crisis.
Colm McDonagh, head of emerging market debt at Insight Investment, said developed market investors' direct exposure to the country's debt has been limited in the past, but it is now a more pressing concern among investors, owing to its impending inclusion in the aggregate index.
However, he explained the credit quality in the government onshore market is "exceptional" and monetary policy, rather than credit risk, is the pressing concern. He added: "It is only when you start going down the curve into corporate credit, which is driven by local investors and not really accessed by foreigners, [where there is a concern].
"China is successfully engaging on reform and a deleveraging process, and it is trying to do so in a way that does not have a big impact on growth."
Cary Yeung, head of Greater China debt at Pictet Asset Management, agreed that most of the corporate debt in China is domestically held, adding the "saving rate is high and [the] FX reserve is solid".
In a recent update to investors, Andy Rothman, investment strategist at Matthews Asia, said the risk of a hard landing in the country is low. He explained the key concern among investors is for offshore dollar-denominated corporate debt, where rising defaults are expected.
He said: "The potential bad debts are corporate, not household, debts and were made at the direction of the state - by state-controlled banks to state-owned enterprises. This provides the state with the ability to manage the timing and pace of recognition of nonperforming loans.
"It is also important to note that the majority of potential bad debts are held by state-owned firms, while the leverage of the privately owned companies that employ the majority of the workforce and account for the majority of economic growth is not high."
He added that cleaning up China's overall debt problem "will be expensive, but will not likely lead to the dramatic hard landing or banking crisis scenarios".