Is China a ticking economic time bomb?

Yes, according to many analysts, who underline the country’s credit boom. For example, a research note by Standard Chartered, which was published on July 21, noted China’s total debt to GDP ratio had surpassed 250 percent. You could have shrugged “so what” if it was not the world’s the world’s biggest trading nation and second-largest economy.

Economics consultancy Oxford Economics argues “a [Chinese] financial crisis would have strong effects through trade channels, especially in Asia and for commodity producers.” The country’s limited global financial linkages could curb financial contagion. But if the crisis were to spread to Hong Kong, it could spread through the city’s international banking system. Global confidence would be undermined as well.

Cross country evidence suggests we should really be worried: As the IMF notes in its most recent report on the Chinese economy, which was released on July 31, credit booms of a similar size have often lead to a recession, banking crisis, or both in the past. But the Fund also underlines that China is more resilient than precedents: “Total public debt is relatively low; public sector assets are large; domestic savings are high and foreign debt exposures low; capital controls limit the risk of capital flight; and the government retains substantial levers to control economic and financial activity.”

That doesn’t mean there are no risks. On the contrary, as IMF economists noted in the teleconference for the report, to which I dialed in from my Shang Hai-Beijing train, the real estate sector is at the center of a web of interwoven vulnerabilities:  For one thing, the economy has relied too much on investment, especially in real estate, after the global crisis. Together with construction, it accounted for 15 percent of the 2012 GDP and a quarter of fixed-asset investment.

To finance this rapid investment, firms and local governments have borrowed from banks and shadow banks, which were set up to bypass banking regulations. As a result, corporate debt rose from 92 percent of the GDP, on average, from 2003 to 2007 to 110 percent in 2013. Most of this surge in leverage is concentrated in a few large firms in real estate and construction.

Recent data suggests the real estate market is undergoing a correction. Both residential and commercial real estate are in oversupply across most regions. This is bad news not only for the indebted firms, but also for their lenders, who are exposed to the sector through household mortgages and the use of real estate as collateral for other loans as well.

Local governments, on the other hand, are dependent on revenues from land sales, which made up 7 percent of the GDP in 2013, to finance their large public infrastructure projects. Tax revenues from real estate and related sectors make up as much as one-fifth of total tax revenues in some provinces.  Adding all these up, two IMF economists estimate a decrease in real estate investment by 10 percent could reduce growth by 1 percentage point.

Analysts should be worried about the real estate sector in China, not leverage per se. Turkey’s real estate woes, which I have been highlighting since 2012, look like a joke compared to China’s – even though they share some characteristics, like leverage and oversupply.