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Estimates for China’s local government debts are now close to $3.3 trillion. Some analysts though believe that the government need not be duly concerned about rising bad debts in its banking sector, as their central bank’s extensive foreign reserves is easily enough to recapitalize the banks. What these analysts fail to understand is that these reserves were not accumulated merely by savings, but also involved more borrowing by the People’s Bank of China.
China’s great rebalancing act has begun. But how successful and orderly the rebalancing process will be will depend on how realistic the government are in their growth projections. What is clear is that China can no longer accommodate 7-8 percent annual growth if it truly hopes to cure its severe domestic imbalances.
There have been many cases in which foreigners were able, perhaps because they tend to be more objective, to identify risks earlier than locals. Despite the claims of the traditional China bulls, there is a great deal of worry among China economists living and working in China about the sustainability of the current growth model, and top officials too have made it obvious that they see the need for reform as urgent.
The slew of economic data released last week has confirmed the worst fears of many global investors: China is serious about rebalancing its economy and growth rates of 6 – 7 percent will no longer be encouraged. Attempts to keep growth above that level will simply mean that it will take much longer for China to fix the underlying problems in its economy, that the costs will be much greater, and that the risk of a disorderly crisis will increase.
As monetary policy across the eurozone was made to fit German needs, excess German liquidity – accumulated from years of trade surpluses and policy controls – was easily exported into Spain and other peripheral European countries which all saw their trade deficits expand dramatically. In fact, the subsequent imbalance became so large that it led almost inevitably to the European crisis in which we are today.
China wants to raise its disproportionately small share of consumption as the cornerstone effort to close one of the world’s widest income gaps and quell rising discontent among those who feel they have missed out on the country’s blistering expansion of the last three decades. Consumption growth is itself dependent on investment growth, and this is more true in the inland provinces than the urbanised coastal regions. But will China be able to maintain consumption growth once investment growth is sharply reduced?
In a system in which almost all the growth is driven by increases in investment, and in which an increasing share of investment is being wasted on factories, bridges, real estate, airports, and other projects that have little or no economic value, rising debt can be a very worrying problem since the ability to service that debt is rising much more slowly than the debt. But if Beijing wants an economic revolution without soaring debt, what exactly are they going to do?
Except for lower debt refinancing costs, the fundamentals of peripheral eurozone economies have not improved in the last six months. At best they are unchanged, but they are probably worse. The region’s crisis continues to be just a liquidity crisis as far as policymakers are concerned – and not caused by problems in the “real” economy. But is peripheral Europe really suffering primarily from a liquidity crisis? When do we call it a solvency crisis?
In 2012, we saw the end of what some call the first stage of the global financial crisis. Most of the deepest problems have been identified and market reforms are underway to ensure that economic imbalances reverse themselves. But whether the imbalances reverse in an orderly or disorderly manner will depend on political decisions, decisions that will set the stages for future growth or future stagnation.
Economic history suggests that most countries fail in the reform and adjustment process precisely because the sectors of the economy, not to mention individuals, that have benefitted from the distortions are powerful enough to block any attempt to eliminate those distortions. But it is certain that not everyone in China is confident that Beijing will be able to force through the reforms, as reports suggest that nearly 6 trillion dollars left the economy illicitly over the last decade.
According to an IMF study released late last year, there is now strong evidence that China has been over-investing significantly over the last decade – leading to sustained economic growth rates at the expense of a suppressed consumption base. But even as China embarks on a new era of economic rebalancing, any attempt to reduce its reliance on investment-led growth may cause severe economic repercussion, while doing nothing may also lead to further financial fragility.
The big news in the last few weeks has been the relatively positive economic data suggesting that Beijing could be in for a rebound. However, the “relief” data tell us nothing about the health of the underlying economy. In fact, growth rates in China will continue to slow dramatically in the next few years and if there are temporary lulls, as there must be, these do not represent any sort of bottoming out at all.