In his final press conference as Chinese Premier in March 2003, Zhu Rongji confidently declared that, ‘all the tasks needed to sustain economic growth over the past four years have been completed.’
Fast forward four years to the National People’s Congress in March 2007 the annual meeting of the State’s highest body. Current Premier Wen Jiabao offered a very different message in warning, ‘the biggest problem with China’s economy is that growth is unstable, unbalanced, unco-ordinated and unsustainable.’ This was all but reiterated by President Hu at the recently concluded five-yearly Congress in Beijing with his admission that the current Chinese reliance on investment and export-driven growth is becoming untenable.
Premier Wen’s remarks were remarkably honest by any standard, especially in a country where the reputation of the Party means everything. But it was no slip of the tongue. Premier Wen repeated the same warning at the follow up press conference and has done so periodically since then.
Trade between ASEAN and China is tipped to rise to about US$200 billion in 2008. Fifteen years ago, it was one twentieth of today’s level. Is the Chinese dragon an unstoppable economic force or should we prepare for a bumpy ride ahead?
In fact, Premier Wen’s warnings are spot on.
Recent concerns about rising inflation and volatility in its stock markets constitute a very small tip of the iceberg. Chinese export-based growth will fall when Americans finally stop living beyond their means. But the greater danger lies in China’s domestic investment addiction which is currently the driving force for most of its growth, the global commodity price boom, and our optimism about China.
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Thanks to Sharyn Raggett |
According to a 2006 IMF study, 75 per cent of China’s growth comes from capital investment. In other words, the amazing growth rates are largely the result of pouring money into investment projects. Since 2000, fixed asset investment has increased by between 25-30 per cent each year. Investment bank Morgan Stanley estimated that fixed investment exceeded about US$1.3 trillion in 2006 (roughly the same amount as China’s famed foreign reserves). The State, through State-owned-banks (which comprise about 95 per cent of the financial sector) directs most of it. Who said China was no longer a command economy?
But there is ample evidence that this State-directed, force-fed investment strategy is unsustainable.
Firstly, World Bank findings indicate that about one third of all recent investments are wasted, and this figure is rising. In the 1980s and 1990s, it took $2-3 of new investment to produce $1 of additional growth. It now takes about $5 invested for $1 of additional growth. Incidentally, this is worse than even during the Mao period in which it took $3 of investment for $1 of growth.
Second, China is suffering the effects of massive and chronic ‘overinvestment,’ over-capacity, and declining productivity. For example, about nine out of ten manufactured goods are in over-supply and have been for almost a decade. Chinese companies keep pumping money into making goods, building roads and infrastructure, and erecting buildings that are not used or needed. No wonder achieving growth is becoming less efficient. The Chinese are clearly getting less and less bang for their buck.
When this amount of capital is being wasted, there are serious flow-on effects.
About 70 per cent of capital lent out by banks heads straight for China’s State-owned-enterprises (SOEs); which, by the way, only produce about 30 per cent of the country’s output. Most of these SOEs are coddled and protected, operate in the most important sectors that are out of bounds for private enterprises, and continue to receive capital even if they remain unprofitable and inefficient (as is usually the case). They are also beset by bad management practices most senior managers being either Party members, or people with close links to the regime. Unconnected individuals, even those with Harvard MBAs, need not apply.
Meanwhile, promising private businesses in China are starved of capital, or are shut out from competing in China’s ‘key strategic’ industries.
Anyone knows that capital should chase profits in a healthy growth economy. But when so much capital is wasted, the build up of bad debts is inevitable. In 2006, Ernst & Young estimated that there were about US$911 billion worth of non-performing-loans (NPL) floating within the Chinese financial system about 40 per cent of their GDP. Standard & Poor’s recently put out a report suggesting that the true NPL figure could be closer to 60-70 per cent of GDP.
Moves to arrest this situation have been tactical rather than long-sighted. Since 2003, the Chinese Government has injected over US$50 billion into the four main State-owned banks alone to maintain their liquidity. Furthermore, since 2000, the regime has created five ‘Asset Management Companies’ (AMCs) to take on US$230 billion worth of NPLs in order to improve the balance sheets of China’s banks.
But Premier Wen’s admissions are only part of the truth. Loans have increased 30-50 per cent per year since 2000. SOEs receive an ever increasing proportion of these loans. And the levels of NPLs have been rising about 2 per cent a year.
The regime has seen this coming for a while but can’t stop it. Why?
For starters, remaining in power can be an expensive exercise for authoritarian regimes. The traditional supporters of the regime largely work in these SOEs and keeping the companies alive at any cost is needed to placate the supporters and maintain their allegiance. SOEs still employ about 80 million Chinese.
Furthermore, the regime has staked its modern legitimacy its right to rule on growth. It can ill afford to stop this force-fed growth strategy, no matter how inefficient it is, in order to co-opt the burgeoning middle classes. Any slowing of growth even if it is essential to restructure the economy has serious political consequences for the Party.
We should be worried about our stock portfolios should China falter. But Premier Wen has much greater concerns how to keep himself and his Party in power.
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