By Paolo von Schirach
August 28, 2013
WASHINGTON – The official news about China is that the number two world economy, expertly managed by the careful Beijing technocrats, is adjusting to a slower but still very impressive rate of growth. After an amazing almost 30 year run with more than 10% growth, year after year, from now on China will be cruising at 7.5% a year. If you think that Europe is barely above zero, while the once mighty America is advancing at a pitiful 2% rate, 7.5% is fantastic.
Too much debt
Well, this is what appears. But it is not so. Not even close. The truth is that China’s growth is largely artificial and now mostly debt driven. And debt is growing at an alarming rate. If you read the hard-hitting pieces on China’s debt crisis published by The Financial Times on August 27 and 28, you get a truly scary picture. China’s construction boom, itself one of the major drivers of GDP growth is based mostly on speculation and enormous amounts of bad debt that now call into question the solvency of many local financial institutions. Likewise, Chinese corporations for years over estimated demand for almost everything. As a result there is enormous overcapacity in practically every sector, from coal to chemicals to steel. Corporate debt, much of it held by non official banking institutions, has skyrocketed.
And this is has nothing to do with the predictable ups and downs of the business cycle. Here you have a major country whose growth is now sustained mostly by an enormous amount of debt. The good news is that China’s exports over time generated huge cash reserves. However, if a large portion of this capital will have to be used to cover all this red ink, there will be a lot less available for productive investment. Therefore, assuming that this scenario is correct, forget about 7.5% growth, year after year.
Local governments and corporations are in trouble
Just a few illustrative facts drawn from the excellent FT articles referred to above. China is now the most indebted among emerging markets. Aggregate debt (corporate, household, government) has soared from 40% in 2007 to 100% in 2012. Local government debt usually does not include debt carried by local non-bank financial institutions. Therefore, while official figures indicate local government debt level up to 16.8% of GDP, in truth this goes up to 57.8%.
At the local level, local governments used to make money by expropriating farm land that was then sold to developers. Land holdings were used as collateral to obtain cash that would finance infrastructure. Well, now the construction boom has halted because developers have over built. Many of them are in big trouble as they have unsold inventory that cannot be liquidated. In the meantime all the sectors, such as steel and cement, that used to be driven by the construction boom are suffering because of demand contraction. Back to the local government, with the end of the construction boom, now they own far less valuable land that is no longer accepted as collateral. Hence a mounting debt crisis at the local level.
Back to industry, many state-owned corporations now are kept artificially alive via easy government credit funneled to them via state-owned banks. Smaller companies that do not have easy access to credit are struggling. Some now pay their bills through promissory notes. Others disguise their troubles through increased unpaid leaves for their workers, so that official employment numbers appear unchanged.
As all this is unfolding, we are told that there is no problem. And this is indeed the real problem. Denial and obfuscation is not a good way to deal with an emerging crisis. Remember Greece? Until the day (back in 2009) in which the Greek Government announced that it had cooked the books regarding the actual level of its debt, it all seemed perfectly normal.
In the US we have had our spectacular 2008 crash. While we can debate how the main actors and the regulators did not see this coming, after the collapse policy-makers and the public knew what had happened. And, sure enough, we have had our own gigantic bail outs. Still, when the Federal Government essentially took over General Motors, it did so publicly, at the same time demanding a credible restructuring plan that included closing down facilities, destruction of jobs, plus salary and benefits cuts for those lucky enough to keep a job.
There is no such publicity and transaparency in China. Ttherefore there is far less pressure to restructure in order to obtain leaner and more competitive state owned corporations. As to the local governments and their troubled finances, most likely their debts will become government debts. Still, debt is debt –and it slows you down.
In the end, for sure China must have many healthy companies that are doing and will be doing well. Still, digging a bit deeper, as the FT has done, we discover a country with huge and as yet undeclared systemic problems. It is going to take time and a lot of money to fix all this. China’s economy will stay large. But it will be far less impressive than you would have thought.