Sabtu, 04 Januari 2014

China's debt problem

If you have seen, or heard about, China's wonderful infrastructure, have you wondered where the money is coming to finance all this ?  The laws of economics apply equally to China, as to the rest of the world. There is no free lunch. So where is the money really coming from ? This is a complicated question ; China's economic model is not easy to grasp for any outsider, but perhaps we can take a peek at it.

Infrastructure spending is not necessarily a profitable business - returns to investors are meagre from roads, railways, etc etc. In China, as in most countries, the government is the one that invests in, and builds infrastructure.  Since 1980, China has been growing at double digit rates. That growth resulted in big increases in tax revenues to the government. Chinese are also a nation of big savers. With growing incomes, came growing savings which were all vacuumed into the state banking system. The government spent a lot of it on infrastructure - banks are all under government control anyway and they were told to lend to industry and infrastructure. Since all land is owned by the government and since land prices rocketed, governments made huge money leasing land to the private sector. All in all a massive party, if you'll pardon the pun.

Came 2008 and the global financial crisis. China being an economy that relied heavily on exports, the effect was instantaneous. However, China could not afford to slow down; the political legitimacy of the Communist Party is predicated on continuing high growth and economic prosperity. So it turned the tap on investment - banks were told to lend, no matter what and growth rates continued to be high. Cities built shiny buildings, huge metros, big highways, added manufacturing capacity etc etc much of which is underutilised and certainly not providing decent economic returns. If you invest with little or no return, some day or the other you have to pay the bill.

Now the chickens are coming home to roost. China suffers from the same problem as India - the central government is largely fiscally prudent, but state and local governments indulge in the worst form of profligacy. Out came the data a few days ago that China's local public debt has exploded from very little to US$ 3 trillion - 58% of China's GDP. Since 2008, 80% of bank lending has been to local governments. And much of this money has gone into spending that will generate no return. While 58% of GDP is itself not a very high figure and much lower than say US or Japan, the rate of growth in debt is staggering (70% in 3 years) and if it continues like this, it will reach unsustainable levels.

China has a debt problem. The Chinese government knows this very well and a year or so ago forced banks to contract lending.  The impact on growth was immediate - it alarmed the government and they turned the tap on again.  A few weeks ago, China faced a short term liquidity crisis and the central bank was forced to pump cash into the economy.

The world will watch China's actions carefully. They will fiddle with the tap turning it on and off and adjusting the flow to check the growth in public debt and at the same time not let economic growth go down too much. This is an inexact science and to manage this at a national level, and that too for the second largest economy in the world, is extremely tough to do. If they get it wrong, the consequences will not be just economic - given China's system,  it will be political as well.

Longer term, the cliche of an investment led economy turning to a consumption led economy is the medicine economists prescribe for China. Easy to prescribe, not easy to administer. Unlike in say India, where political legitimacy is not dependant on macroeconomics, in China it is. If the economy wobbles, so will China's Communist Party. Any political turbulence in China will be painful, not just for China, but for the whole world.

I know economics is a dull and boring subject, but watching what China does and what the outcome is, will be fascinating if you are interested in such things. China is not a gold mine anymore. There are significant risks to the global economy from China. The party may not be coming to an end, but the music is sounding a bit off key and not so loud at the moment. Funny, you could also say that about the Communist Party.

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