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Chinese Economy: Back To The Future

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Pacific Money

Chinese Economy: Back To The Future

In allowing rapid credit growth again, is Beijing simply postponing the inevitable?

Chinese Economy: Back To The Future
Credit: Chinese currency via Shutterstock.com

In a bid to revive its flagging economy, China has gone back to its old ways, with rapid credit growth sparking a pick-up in the “old economy” sectors of construction, housing and manufacturing. However, keeping the good times rolling by delaying reforms could yet bring bigger problems for the world’s second-largest economy, according to analysts.

On Friday, Asia’s economic heavyweight reported a 6.7 percent increase in gross domestic product (GDP) in the first quarter compared to a year earlier. Despite being its slowest expansion in seven years, the rise was in line with economists’ median projections and in range of the government’s stated target of 6.5 percent to 7 percent GDP growth for the full year.

Industrial production expanded by 6.8 percent, retail sales by 10.5 percent and fixed asset investment by 10.7 percent, all exceeding the previous quarter’s results and beating analysts’ forecasts in what economists described as a “stabilization of the old economy.”

The housing market has responded accordingly, with property sales up 54 percent by value in the first quarter and investment rising by 6.2 percent. The GDP data also followed stronger-than-expected trade data released earlier in the week, with exports rising by nearly 19 percent in March compared to the previous quarter’s 20 percent fall, while imports improved from an 8 percent drop in February to only a 1.7 percent decline in March.

“The economy has stabilized thanks to a flood of liquidity and improved sentiment in the property market,” Credit Suisse economist Tao Dong told Bloomberg News. “It is not clear whether the momentum is sustainable. So far, the government seems to be the solo singer. It is critical to re-engage private investment.”

China’s credit binge has reportedly reached the same levels as during the heights of the global financial crisis, according to the International Monetary Fund’s former chief representative in Beijing, Jonathan Anderson.

Anderson told the Australian Financial Review that total credit growth was expanding at an annual rate of 21 percent, far higher than the reported 14 percent growth, with the extra credit disguised via “debt-like instruments funneled through China’s non-bank lenders.”

“This is still an economy in the throes of an extraordinary and massive credit bubble,” Anderson told the Australian financial daily.

“During the past calendar year China has added just as much debt relative to underlying activity [as] it did during its massive post-crisis 2009 stimulus boom.”

In March, new yuan-denominated loans grew by 89 percent from the previous month to 1.37 trillion yuan ($211 billion), while government spending also increased by 20 percent to 1.68 trillion yuan. Total social financing, a credit measure that includes both bank and nonbank lending, hit a historical high of 6.59 trillion yuan in the first quarter, while corporate bond issuance rose to nearly 700 billion yuan compared with around 550 billion yuan for January and February combined.

The extra credit has provided a welcome boost for China’s battered steel sector, which has enjoyed a 25 percent price rise since the start of the year, while the iron ore price has jumped by 37 percent to around $60 a ton, aiding miners and boosting budget coffers for exporters such as Australia. The oil price has also surged 60 percent higher, with the Brent crude price climbing to $44 a barrel compared to its level below $30 earlier in the year.

In March, China’s steel production increased by 2.9 percent to a record 70.65 million metric tons, in what Mysteel’s Xu Xiangchun described as “an extraordinary figure.” The output rise also comes despite Beijing touting plans to cut overcapacity in the sector from 1.1 billion tons to around 800 million tons by 2020, although this would still exceed domestic demand, leading to calls from steelmakers in Europe, the United States, Japan and Australia for more rapid cuts.

Mysteel expects China to export around 100 million tons of steel in 2016, which although down 10 percent on last year’s level would still be five times more than it exported in 2009. As noted by The Diplomat, official plans to cut 1.8 million jobs from the nation’s coal and steel sectors as part of a planned switch to a services-driven economy have had a damaging impact on the sector, but the reduction in overcapacity appears far from finished.

Impaired loans have also hit their highest level in a decade in China, with ratings firms and the IMF citing China’s debt as a key risk facing its economic outlook. But with Beijing vowing to double the size of the economy by 2020 from 2010 levels by maintaining a 6.5 percent average GDP growth rate over the next five years, even more fiscal and monetary stimulus is likely.

As Chinese Premier Li Keqiang said in his annual speech to the National People’s Congress, “Development is of primary importance to China and is the key to solving every problem we face.”

China’s “remarkably smooth” growth numbers have been questioned by analysts, who have noted that the GDP growth rate has changed by a modest 0.2 percentage point on average each quarter since 2011, less than half the mean of the rest of the world’s top 10 economies, despite major gyrations in prices of commodities, currencies and stocks.

Capital Economics’ “China Activity Proxy” index has put the real growth rate at closer to 4.1 percent in the first two months of 2016, although recent stimulus measures may have “helped to avert a deeper downturn.”

Yet the much-hyped switch from investment to services-driven growth is occurring only gradually. In the first quarter of 2016, the consumer sector’s share of GDP rose to nearly 57 percent, up from the previous year’s level but still well below the 80 percent rate seen in the world’s biggest economy, the United States, and even 58 percent in India, currently the fastest growing major economy.

“I don’t see much structural reform in 2016,” IG Markets analyst Angus Nicholson told the Wall Street Journal. “The government is returning to the same old forms of growth.”

Economist Intelligence Unit economist Tom Rafferty had a similar warning for Beijing, saying in a research note: “Today’s released data ought not to distract from the fact that the structural issues facing China’s economy remain unresolved.

“It has taken considerable monetary and fiscal policy loosening to stabilize economic growth at this level and this effort has distracted from the reform agenda that is fundamental to long-term economic sustainability.”

Asia’s miners and other exporters to China will have celebrated the reported pickup in growth, regardless of its source. But while delaying politically tough reforms of state-owned enterprises and more radical restructuring may provide Beijing with temporary relief, postponing the inevitable could yet prove even more painful.