In the second quarter of 2021, the macro leverage ratio continued to decline, falling by 2.6 percentage points. This brought the total decline in the first half of the year to 4.7 percentage points, achieving what Ray Dalio terms a “beautiful deleveraging.”

Disaggregated by sector, the household leverage ratio remained largely stable, declining by 0.1 percentage points in the second quarter and by 0.2 percentage points over the first half of the year. The leverage ratio of the non-financial corporate sector fell significantly by 2.6 percentage points during the quarter and by 3.5 percentage points cumulatively over the first half, marking a fourth consecutive quarterly decline. The government sector leverage ratio rose marginally by 0.1 percentage points in the second quarter, but still registered a 1 percentage point decline over the first half of the year, as bond issuance remained sluggish.

The “beautiful deleveraging” was primarily driven by strong nominal GDP growth. However, several concerns accompany this seemingly benign deleveraging process:

1. The widening gap between the Producer Price Index (PPI) and the Consumer Price Index (CPI) has squeezed profit margins and survival space for downstream industries;

2. Continued aggressive deleveraging by firms may trigger a balance sheet recession;

3. The recovery of the real economy is losing momentum—consumption remains below expectations, infrastructure investment is weak, and export growth has begun to decelerate;

4. Many local government financing vehicles (LGFVs) are essentially zombie enterprises with high default risk.

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