China, Debt and Growth

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Macroeconomics

What goes around comes around they say, along with other equally useless phrases like “all good things come to an end.” China has had a good financial crisis of that we don’t doubt. Growth remains robust and has not only carried the country through double digit growth while the west has gone backwards but it has carried much of Asia along with it, bringing increased prosperity to South Korea, Taiwan and many neighboring economies. Perhaps the prime minister, Wen Jiabao, in March of last year can be forgiven for crowing “What is great about socialism, (is that it can) make decisions efficiently, organize effectively and concentrate resources to accomplish large undertakings. In the eyes of many, authoritarianism has gained a new legitimacy. With an enormous state machine as China enjoys, one can indeed organize and achieve on a mammoth scale. China has allowed its provincial and municipal governments to spend unprecedented amounts of money over recent years. The money has gone toward investment largely by local governments in infrastructure projects that will have some kind of income stream in the future, capable, at least in part, of servicing the debts incurred. But a recent Economist Intelligence Unit article reports Fitch as estimating up to 30% of this local government debt could turn bad. So how much are we talking about I hear you ask? Well a recent study by the People’s Bank of China showed that these debts stood at Rmb14.4trn (US$2.2trn) at the end of 2010, equivalent to approximately 35% of GDP. This is on top of the central government’s relatively modest debt equivalent to about 20% of GDP.

Source: The Economist

As these graph show, although China’s GDP has risen strongly, with current projected trends to continue, debt has shifted from banks and central government to the less regulated local government level. This, either directly or via special financing vehicles for which the local government will ultimately have responsibility. The EIU reports that a central government rescue of around 20% (never mind the 30% estimated by Fitch) of the local government debt would take a significant bite of GDP, possibly as high as 8%. For purposes of comparison, this sum would exceed the US Troubled Asset Relief Program (TARP), the 2008 bailout in the US, equivalent to just under 5% of GDP. With massive foreign exchange reserves, Beijing can handle such sums. However, interest rates (and personal savings rates) will take the impact as they will likely remain low and in reality rates already appear negative.   Those personal savings finance government borrowings but the low interest rates paid depress attempts to move the country toward a more consumption and less investment led growth model.

The fear relates to a slow down in the housing market and manufacturing could meet a rise in non performing bank loans. As a result, China faces continued negative real interest rates on deposits slowing attempts to move the economy toward more internal consumption. If the EIU’s scenario pans out, China could find itself in a prolonged period of more modest growth in the years to come. We have seen this before with China. But in the future, the slowing rate of urbanization and an aging population will limit the vibrancy of that economic recovery. We can only guess whether the wonders of socialism will continue to guarantee robust growth for the next generation.

–Stuart Burns

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