Paolo von Schirach
April 17, 2013
WASHINGTON – Is China in trouble? The current 7.7% growth rate, while very high by world standards, is not what it used to be. Migrant laborers are becoming more expensive. The export-led formula that worked so well for decades is no longer a sure thing. Foreign markets are saturated; and if Chinese goods over time get to be more expensive where is the advantage in buying them? On a different note, pollution in China has reached horrible levels, requiring new drastic and very expensive environmental protection measures that cannot be implemented within a reasonable time frame.
China’s debt
And now China’s debt has been downgraded. But how is this possible? China is not perennially semi-broke Southern Europe. It sits on trillions of dollars of reserves. It is certainly not going bankrupt.
True enough, there is no major crisis on the horizon. But there is slow erosion. And the erosion has been caused by a prolonged easy money and easy credit policy aimed at countering the impact of the global financial crisis. At the local level, provinces and municipalities while prevented by law to issue bonds have figured a way around the obstacle and created instruments aimed at raising funds to finance public works and other needed infrastructure.
Local governments borrow too much
But now even Chinese analysts are expressing concern, in a very public way, that all this has gone too far. Local governments are now deeply in debt. Various estimates indicate that the total exposure of all local governments may be somewhere between $ 1.6 and $ 3.2 trillion. If we take the larger estimate, this is almost 40% of the Chinese economy, as a recent FT front page story noted. There is no way that all these local governments will be able to raise the revenue necessary to pay back these bonds.
So, do we have a huge default in the works? No, not that. It is obvious that China’s central government will intervene, in a massive way if necessary, to avoid any disruption. And it has plenty of resources available.
Make believe economic growth
Still, the creation of a large amount of debt that cannot possibly be paid back is a bad sign. It is a sign of a semi-desperate attempt to make the economy appear much better than it is. Local governments want to show growth. Construction, shopping malls and new infrastructure are ways to keep contractors in business and people employed. But when there is no money to pay the bills then we all realize that in order to avoid a stagnation problem we created a bigger one.
Political troubles ahead?
Sure enough, China can pay its bills. But the price will be less future borrowing and less economic activity. And this will result into an even smaller rate of growth. And less growth may well translate into political trouble for a national leadership whose only source of legitimacy is good economic stewardship.