Suparna Goswami Bhattacharya
The dragons have been the envy of many countries for long. With the economy growing in double digit for most of the 2000s, to being the largest manufacturing hub in the world, China’s growth story so far has been nothing short of a dream.
However, as it happens in life, one has to finally wake up to reality. And today, China’s reality is not something it had dreamt of six to seven years ago. To be honest, it would be hard to pinpoint in black and white how the Chinese economy is growing as signals are mixed. Inflation in China is at its weakest level in five years, new home sales and foreign investments are declining. All in all, China’s growth story is slowing and the economy is now chugging at the rate of 7.3%.
To be fair, growing at that rate is still a dream for many developed economies in the world, or even for India, which is often pitted against China. Mired by corruption and large bureaucratic process, India is now struggling to keep up its GDP growth rate at 6%. In fact, China’s experience from 1977 to 2010 already holds the distinction of being the only instance, quite possibly in the history of mankind, with a sustained episode of super-rapid growth of more than 6 percent for more than 32 years, point out Harvard economists Lant Pritchett and Lawrence H Summers.
“In fact, there are only two countries that have come close to the Chinese growth rate. Taiwan grew by 6.8% per year between 1962 and 1994 while Korea grew by greater than 6% between 1962 and 1982. And in both the cases, the growth eventually slowed down,” says Vivek Kaul, author of the Easy Money trilogy.
However, James Rickards, economist and author of Death of Money, does not trust the Chinese GDP growth figure. “I know they print 7.5 percent, but in reality it is not more than 4 percent, thanks to the amount of waste they generate,” he says.
So, is China’s slowing rate of growth a hype or is it something that needs to be looked into urgently?
“I will not call it hype. However, having said that, this does not mean that the Chinese economy will start collapsing starting tomorrow. The precise time of such things is next to impossible to predict,” says Kaul.
Since the 2007/2008 global financial crisis (GFC), China has experienced strong credit growth. The crisis and the resulting rare synchronous recessions in the developed world exposed China’s economy, especially its export sector, to a large external demand shock, slowing growth. Beijing deployed massive resources to restore growth to counter the economic and social impact of the slowdown. In late 2008, China announced a fiscal stimulus package of about $600 billion over two years. The modest fiscal measures were augmented by a significant expansion in credit known as total social financing (TSF), covering a mix of loans, and even some equity financing via the large policy banks, which are majority government owned and controlled.
Post-GFC, new lending by Chinese banks has been consistently around 30 percent or more of GDP. According to the World Bank, almost all of China’s growth since 2008 has come from government influenced expenditure.
“This expansion led to a rapid increase in the level of debt. Due to unreliable data and measurement problems, the exact level of debt remains unclear,” says Satyajit Das, a former banker and author of Extreme Money and Traders, Guns & Money.
And China, so far, has turned a blind eye to the problem. Officials in China started to talk about tackling debt in 2010. However, since then there is little that they have done. And even today, Chinese officials prefer to bail out companies who can be termed as compulsive defaulters.
Kaul feels it is futile to just blame the Chinese as all governments around the world, irrespective of their stand on capitalism, end up rescuing firms. “What do you think the US government did in the aftermath of Lehman Brothers going bust? It rescued financial firms which were not doing well because if it had let them fail, the impact on economic growth would have been even worse. While governments may vouch for capitalism in public, they do not like to see firms failing,” he remarks.
Investment without sufficient returns
A big problem with the Chinese government is that it invests heavily without thinking much about the returns it is going to generate. “Investment in new assets is usually focused on large-scale infrastructure and property. The major concern is that many of the projects will not generate sufficient income to service or repay the borrowing used to finance the investment,” says Das.
For instance, the city of Tianjin, about a half-hour journey by high-speed train southeast of Beijing, has invested more than $160 billion to create a financial centre. The amount spent is almost three times that spent on China’s Three Gorges Dam, one of China’s costliest projects. And the returns are not expected to be much.
Another big problem in China is the huge property bubble. In fact, a substantial part of the China growth story is built on the belief that real estate prices will only go up. And the government has often encouraged banks over the years to lend to people interested in buying property. The problem now is home prices have started to fall. Home prices fell by 9.3% between April and June 2014, in comparison to the same period last year. Further, data from the National Bureau of Statistics shows that in August 2014, home prices fell in 68 out of the 70 major cities.
“The slowdown in home sales has led to the accumulation of unsold homes. And this is a worrying sign for the Chinese economy. Land sales are a very important part of revenues of local governments. And if the Chinese are not buying as many homes as are being produced, the local government will not get the kind of prices they were getting for their land in the past,” says Kaul.
To conclude, the government in China is trying its best to not to repeat what happened with Japan in the early 1990s. But the similarities are too stark. In both cases, investment levels were high, in similar areas such as property and infrastructure. Chinese fixed investment, at around half of GDP, is higher than Japan’s peak by around 10 percent.
“But at the onset of its crisis, Japan was much richer than China, providing an advantage in dealing with the slowdown. Japan also possessed a good education system, strong innovation, technology and a stoic work ethic that helped adjustment,” says Das. By contrast, China relies on cheap labour to assemble or manufacture products for export, using imported materials. Labour shortages and rising wages are reducing competitiveness, Das says.
Whether another Lehman crisis is round the corner, only time will tell. But surely a slowdown in China will affect the world economy.