Rebalancing all this will not be easy.
Why? First consider the issue through the prism of “political resolve.” Subsidies, be they implicit or explicit, as well as ever increasing amounts of easy credit, have been addictive. What’s more, they have been allowed to continue for so long that “addict” sectors and industries (particularly state-owned enterprises with better credit access) have grown out of proportion—both in terms of their importance to the economy and their influence in China’s political patronage system. Examples are numerous, but shipbuilding, steel, aluminum and the solar industry are most often cited.
This resolve has been found wanting in the past. Former Premier Wen Jiabao talked many times about tackling China’s “unbalanced, uncoordinated, and unsustainable” economy and the associated real estate bubble, but ultimately, Wen’s government was unable to deliver. Increasing consumption was included as a goal in the last five year plan, and had been discussed by various leaders for years. Again, changes thus far have not been sufficient, and consumption remains relatively weak.Enjoying this article? Click here to subscribe for full access. Just $5 a month.
Part of the reason was that the comfortable external environment which had been absorbing much of China’s overproduction collapsed in 2008, just as consensus for change in China was building. The post-crisis stimulus unleashed yet more credit and investment, principally aimed at avoiding the biggest fear of China’s leaders – a growth slowdown and unemployment – rather than at putting the economy on a more sustainable, balanced path. Rescuing growth meant a big step backward in nascent financial sector reform. Since 2009, every time measures were introduced to tighten and restrict normal or “shadow” credit, to control the property sector or to rein in local government debt, the subsequent falls in growth rates and feared employment effects prompted U-turns and delays in proposed policies. The resulting piecemeal measures prevented China from rebalancing, and indeed runaway credit growth has continued. Now, time is running out.
The result: One of the biggest questions currently facing the global economy is whether or not the new government of Premier Li Keqiang and President Xi Jinping in Beijing has the necessary political capital (or confidence) to push through the painful rebalancing against entrenched interests and inertia in local governments, state owned enterprises, the export sector and indeed the financial system itself.
On the latter target, the People’s Bank of China (PBOC) appeared to show a great deal of resolve when it recently refused to come to the aid of China’s interbank and money markets as rates spiked and pressures grew. Since then, its stance has apparently moderated slightly but as the potential significance of the new less-supportivereality set in, China’s stock market investors panicked, sending the country’s main indices tumbling.
Yet, here is an example of the second factor affecting China’s rebalancing: As the economy adjusts, the reactions and behavior of various players will have unexpected consequences that could exacerbate any slowdown or increase instability. For example, the recent fall in China’s stock markets effectively delayed the plans of many medium sized Chinese banks to list shares in Hong Kong. At the time of writing, current valuations would breach rules that forbid them listing at low price-to-book ratios. The knock-on effects on their capital raising, and thus business, are significant. This situation may reverse, but it is still illustrative of the kind of unexpected consequences that can ripple out from any attempts to rebalance the economy.