China has been trying to rein in debt, correct the public-private imbalance and spur consumption-led growth. The real danger of the trade war is it risks distracting policymakers from their focus on such structural reformThe trade war that US President Donald Trump launched a year ago has bruised China’s economy. Yet, since 2010 China’s gross domestic product growth has been trapped in a
. Trade war aside, the real danger for China lies in the daunting structural weaknesses in its economy, accumulated through decades of rapid development and growth.
The trade war, beyond denting China’s exports, complicates matters by abruptly distorting Beijing’s ongoing endeavour to disentangle its structural problems.
Even before the 2008 global financial crisis, the Chinese leadership had
declared that China’s growth model was “unstable, unbalanced, uncoordinated and unsustainable”.
China recognised that it was locked in a vicious cycle of ever-heavier dependence on investments in infrastructure and real estate to realise its target growth rate, and that this spawned perilous structural problems.
There are three major problems. The first is high debt at the local government level. Driven by investment-oriented growth incentives, local governments went on an investment binge, relying substantially on borrowing to fund infrastructure projects.
From 2000 to 2017, local governments initiated, on average, fixed-asset investments twelvefold of that launched by the central government, even though local governments’ tax income was merely three-quarters of central government takings.
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As infrastructure projects fail to generate profit in the short term, local governments
keep on borrowing to pay down debt.
According to China Chengxin Credit Rating, by early 2018, the implicit outstanding debt for local governments, which is always embedded in their state-owned enterprises, was between 26.5 trillion yuan and 35.9 trillion yuan (US$3.8 trillion and US$5.2 trillion).
This is nearly 80 per cent of the debt-to-GDP ratio, much higher than for the average developing country.
This towering debt has, to a large extent, drained the savings pool and slowed private investment. It puts the central government between a rock and a hard place: either bail out all local governments, or permit default and unimaginable financial market turmoil.
The second problem is the growing disequilibrium between the private and public sectors. The public sector is less efficient but has better access to bank loans and government subsidies, leaving private enterprises more vulnerable to a liquidity crunch, as China moves to rein in debt.
The recent government takeover of
Baoshang Bank, a small regional bank which had too many non-performing loans, also sent ripples through the private sector.
The bank’s financial institution creditors were repaid only 80 per cent of the principal, shattering the implicit belief that interbank loans were risk-free, for the first time since 1998.
This has led large financial institutions to recalibrate risky assets, and reduce interbank loans to the small local banks that the private sector heavily depends on.
Lastly, the lack of new sources of economic growth is the most imperative challenge. Consumption-led growth is sustainable and benign, but not enough to support the country’s current GDP growth rate. China needs to develop new industries and technologies.
Unicorns are emerging, but too many of these privately held start-up companies valued at over US$1 billion still depend on government subsidies and lack the capability to generate profits.
BYD, despite being China’s
leading electric carmaker, saw its net profit for the first half of 2018 plunge by 72 per cent year-on-year after government subsidies to the industry fell. It has since managed to recover.
In April this year, BYD reported a 632 per cent jump in its first-quarter net profit, buoyed by strong demand for its new energy vehicles. Photo: AP
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The Chinese government is poised to address these problems. In 2015, the central government launched a
deleveraging campaign to end the local governments’ borrowing spree.
In 2018, for the first time, China’s plans for a property tax made it into the government work report delivered at the annual legislative meeting.
The tax, which has been the subject of much speculation for more than a decade, would discourage real-estate speculation and direct that capital into buttressing the volatile stock markets and the manufacturing industry instead. It should also make housing more affordable and free up more income to shore up weak consumption.
However, the trade war has complicated the problems. Besides the stock market turmoil, many analysts now predict that trade tensions will cause China’s GDP growth this year to
To counter this, Beijing has adopted a wide array of policy instruments, and swiftly switched from the deleveraging campaign to another leveraging spree. The policy measures meant to tackle China’s structural economic problems are suffering an about-face as pessimism and grim prospects excessively affected policymaking.For a start, the State Council has allowed local governments to issue debtearlier than usual this year.
By the first quarter, local governments had issued 1.18 billion yuan worth of bonds, practically the whole year’s quota – putting paid to previous painful deleveraging efforts amid mounting concerns about the sustainability of debt.
Meanwhile, China’s property tax plans have taken a back seat and real estate investment has regained momentum, rising 10.9 per cent year-on-year for the first half year, 1.2 percentage points higher than in 2018 – and raising worries that China has returned to the old investment-led growth model.
China’s road to reform is difficult and has suffered setbacks, most recently from the added uncertainties of the trade war. But the Chinese economy should be able to absorb the temporary loss in trade, as seen from its ramping up of exports to Africa and Southeast Asia.
The pain from the trade war will be short-lived, and the Chinese government should stick to its course of reform. China’s future hinges on a sustainable economic growth model that is less reliant on external markets and massive levels of investment.