China rebalancing, a crisis? Yes, and one of magnitude and complexity.

China did not end up with its current imbalances as part of a natural process and therefore the transition itself is unlikely to be natural. 

China is both the here and now and the future, it has untold potential, a growing debt problem (here, here, here, here, here and more in the links below) and a “government” still “seemingly” capable of pissing great distances into the wind.  But working out China for many is tougher than working out the meaning of life itself.

I have concerns over the ease and the speed with which many believe China can rebalance itself from an export led/debt financed investment growth model to a debt financed services and consumption growth led model.  That is how China can transform itself from a manufacturer of goods to the world and builder of infrastructure, to a perfect model of advanced western capitalism? Odd really given that neither model appears to be stable or perfect in its entirety, both representing forms of economic extremism, excess and various levels of maturity/immaturity. 

The issue is not debt alone, but the rate at which it has recently accumulated, especially post 2008 and the imbalanced nature of the economy upon which it rests.  Just because an economy has potential, just because compared to more mature developed country metrics China has some way to go in absolute terms, does not mean that the current force exerted at the turning point is inconsequential.

China’s budget deficit, “augmented”, is considered by the IMF and others to be some 10% of GDP and a recent Breugel post posits that total debt is likely now closer to 300% of GDP, if we include financial sector debt.  Total government debt is now closing in on 60% of GDP and may even be there now: all we need now is a sharp economic shock, a slowing of growth, some defaults and, given the imbalanced nature of the economy, China’s debt profile could traject upwards considerably. 

Many view China as having substantial leeway for government borrowing to fund economic support, but this may turn out to be a quicker moving dynamic than many believe – just look at Spain’s experience.  I also think it worthwhile to reassess the ability of this one party state to makes the types of decisions that are needed to make further stimulus and structural change effective.   Success is a marginal exercise at best and, given the competing dynamics, the margins that impact success I believe are narrower still at present.

Yes, we are now replete with data on the rapid growth of debt post 2008, the dependency on gross fixed capital investment (in particular real estate: note Credit Suisse’s triple bubble proclamations) that has well exceeded the experiences of other developing countries, a deterioration in productivity growth (here, here, here and more in the links below) and excess manufacturing capacity to say nothing of the nuances of its banking and shadow banking systems. 

Excess capacity has been plaguing various industrial sectors, weighing on profitability and on capital spending in steel, cement, aluminium, flat glass and, downstream, electrical and railway equipment. Firms, including many SOEs, are driving down prices to secure market share at home and abroad.

And, yet we are also aware that both capital and debt is still well below the levels that a fully developed China would be expected to have.  We are aware that there are areas where capital can be gainfully employed and productivity raised.   It is not that these two sides do not exist, but that they exist at different points in time.  China has to a certain extent benefitted from a) the focused support of its one party state, b) the low base from which it has grown, c) FDI and global supply chains set up within China and d) the weakening manufacturing base of western economies and the late 1990 to 2007 consumer boom that worked in favour of its dependence on growth in global trade.  Post 2008 things have changed, growth has been maintained but at a significant cost and most of the positive dynamics that have supported its “teflon growth” status look to be on the wane.

And we are not dealing with a linear growth profile because China is transitioning on a number of key fronts:

From export/investment led to consumption/service sector led growth and the residual importance of the first remains significant with respect to legacy debt and GDP dependency. Debt and stimulus may be needed to support both strands of the transition at a time when growth is slowing, the risks to growth are increasing and the negatives with respect to additional debt accumulation are increasing. 

From a centralised state economy to one more able to deal with the successful transition toward a balanced modern economy.  Many of the links below discuss access to bank financing for non state enterprises, the impact of political structure on activity and other issues that are affecting China’s ability to transition.

China is aging and has its own demographic constraints that will soon impact growth and hence ability to bear large increases in debt.

It is also transitioning in its ability to deal with a slower growth world economy: in a sense this is a cog within a cog that creates additional urgency for China’s economy to make the transition and for it to be circumspect with respect to how much financial support it can afford to submit towards supporting the transition. 

And the fifth discussed below: transitioning to a lower debt, lower growth trajectory

How can China balance the debt requirements of an older atrophying model and the debt requirements of the new?  This is especially so given the recent much faster debt accumulation relative to GDP growth, itself occasioned by the large shock to developed economy growth rates post 2007. 

China needs to transition, but much of its own post 2007 financial stimulus must surely have been predicated on what at the time may have appeared to be only a transitory shock to world growth.   Developed economy growth has not recovered its earlier trajectory, and indeed with much of the world more apparently reliant on foreign as opposed to domestic debt financed growth, China’s own transition since then has likely come under additional pressure.  Changing horses has become much more complicated in a post 2007 world.

But we need to step back further to the post 2000 low interest rate environment, housing booms and consumer excess to see that quite possibly China’s economic infrastructure was raised to a higher level than it would otherwise have done up to 2007 and, that post crisis, intervention has focussed on maintaining the trajectory of this edifice.  Surely if this is the case it is not just a question of transitioning between growth engines, changing horses, but scaling back to a lower debt and a lower growth trajectory.  This is before we even consider the demographic transitions yet to hit China as well as its many structural impediments to a more productive, competitive consumer based economy.

The large increase in debt relative to GDP that we have seen is not just a sign of China’s intent but a consequence of the economic and financial shocks that have hit with the global economy for a while now.  While many have long questioned China’s growth statistics, one thing is palpable to me and that growth and the debt that has sustained it has likely been well above that of a more appropriate trajectory, even for a growth mad economy.   Just as the developed world has its own “Debt of Damocles” moments, so does China and current risks to growth have an additional and significant edge.

Many make the mistake of comparing China debt ratios to other developed market debt ratios.  This is worrying on a number of levels:

When we look at global debt we are looking at debt relative to GDP in economies that are mostly much more balanced than China.  The relationship between investment, manufacturing, employment and output sector composition and debt finance is important to debt sustainability and financing.  China’s debt to GDP ratio is therefore likely to be much more unstable and, absent government intervention, much more exposed to default.  We would be better to look at China’s debt relationship in terms of a normalised GDP component balance, which would mean a lower present value.

Unfortunately we have also seen debt rise in the developed world at the same time as headwinds to GDP and income growth have risen, so global debt relationships are not necessarily appropriate benchmarks to the viability of any country’s debt, developed or developing. 

Real world economic models depend to a certain extent on monetary growth generated by new loan creation.  As a result there is a always a latent disconnect between debt obligations and output: that is if income or revenue growth fails to grow at a levels required by higher debt.  The closer debt/capital stock and its rate of growth is aligned to fundamental growth dynamics (population growth, TFP, income) the less volatile the economy is to financial shocks and vice versa.   Matching debt to growth is more important when economies are transitioning given the risks of discontinuities as Martin Wolf stated in a recent article.  Given debt dynamics: high debt levels, zero productivity growth, excess capacity/real estate supply, weak global demand, the discontinuity risks are indeed high.

From the Conference Board – An alarming result from this year’s estimates in The Conference Board Total Economy DatabaseTM is that the growth rate of total factor productivity (TFP), which measures the productivity of labor and capital together, continues to hover around zero for the third year in a row, compared to an average rate of more than 1 percent from 1999-2006 and 0.5 percent from 2007-2012. The challenge on TFP growth is widespread across the globe. Most mature economies including the United States, the Euro Area and Japan show near zero or even negative TFP growth. In China, TFP growth has turned negative, and in India it is just above zero, at 0.2 percent. Both in Brazil and Mexico TFP growth continues to be negative, respectively at -2.3 and -1.7 percent.

Debt is an asset and its valuation and risk is dependent on future flows, mostly short to medium term flows, and their growth rates.  Higher levels of debt and lower future flows imply higher risks of default, which given the risks of transitioning, inter alia, suggests that China debt could escalate some way beyond current levels in order to support a more “orderly” transition. 

If China is to transform smoothly it will need to keep the current financial and economic infrastructure “stable” while expanding consumption and services growth in particular.  It cannot really provide smooth passage to both trajectories without accommodation and I have concerns over how far such accommodation can itself be carried.  We are passing through a point of innumerable constraints: the world’s financial system is especially sensitive to changes in key growth drivers such as emerging markets, especially when developed market debt is dependent on growth from these regions and export dependent emerging markets are especially sensitive to weak developed market economies.  Transition between developing and soon to be developed economies has in fact been a key theme post 2008: key developed economies have been hoping to rebalance away from excessive consumption to higher levels of investment and manufacturing.  China has yet to fully make the transition and so have the rest.

The following chart shows Chinese gross fixed capital investment as a % of GDP: two clear trends are visible, the first the upward move post 2001 as western consumers leveraged up and the second, the post 2008 crisis move as China leveraged up:


Even as recently as 2013, 55% of GDP growth in china was from gross fixed capital investment, investment driven by substantial increases in debt:


China’s GDP is incredibly leveraged to gross fixed capital investment expenditure and in particular, post 2008, real estate investment:

Telegraph UK – The Chinese tax system is highly leveraged to the property cycle, like Ireland’s before the boom broke in 2007. The scale is epic. A study by the US Federal Reserve found that property investment in China has risen from 4pc to 15pc of GDP since 1998. This is even higher than in Japan in the blow-off years of the late 1980s

From an IMF report – Real estate has been a key engine of China’s rapid growth in the past decade. Real estate investment grew rapidly from about 4 percent of GDP in 1997 to 15 percent of GDP in 2014. Residential investment, in particular, has been high compared with that in other countries. Today, it accounts for both about 15 percent of fixed asset investment and 15 percent of total urban employment. Bank lending to the sector accounts 20 percent of total loans. Real estate has strong linkages to several upstream and downstream industries (Liang, Gao, and He, 2006) and sales are also a key source of local public finance. Properties are extensively used as collateral for corporate borrowing

Recent article referring to Credit Suisse and Moody’s analysis – The experts also argue that China is undergoing a “clear cut housing bubble,” pointing to the size of real estate in the country as a share of its GDP. The figure, around 23 percent, is triple that of the US at its peak and similar to peak levels in Spain and Ireland, they said. The analysts added that the Chinese housing market is also oversupplied and overvalued.

So where is the rebalancing going to come from?  Economic activity, and this includes the infrastructure and the capex kind, depends on current levels of flows and financing.  

If various entities cut back on gross fixed capital investment projects there will be areas of the economy that are likely to see a fall back in demand and a loss of jobs, with its associated feedback loops into support services etc. 

So we need to a certain extent compensating flows, although not all flows have the same characteristics: for example productivity/return on capital will vary.  But this assumes that the prior entities remain fully operational: indeed if prior operations have built up excess capacity, then flows may need to more than compensate, if output falls in these manufacturing and infrastructure related sectors.  And with flows affecting debt and asset values, transitions are especially complex.

A mature economy reallocating to consumption and away from investment and from thence to capital depreciation and debt reduction, may have an easier time of transitioning than an economy over built and over funded in certain sectors.   The main reason being starting from a position of excess that productive excess capacity ends up being scrapped, and capital, as opposed to flowing out as a cashflow, is destroyed in the default process.  And we have excess with China and we have capacity and debt default risks, all with their attendant consequences on economic flows.

Scrapping of excess capacity and loan defaults impact bond and equity holders and hence confidence and consumption expenditure, a necessary driver of the transition to higher service sector/consumption dynamics.   It may that China will eat this debt default via central bank asset purchases to support the economic transition.  But planning this will be hard and will not necessarily obviate much of the economic distress associated with these sequences.

It is important to remember that the need to rebalance the Chinese economy away from I to C is to do with a hitherto artificially stimulated growth process: the economy did not end up with the current imbalance as part of a natural process and therefore the transition itself is unlikely to be natural.  That is the process will need to be supported and support requires existing debt and productive capacity support, as well as new debt and support for service/consumption focussed industries.   Since part of the problem of current imbalances is that GDP and debt have become increasingly unbalanced, you have to wonder how much of a transition can be financed and for how long.   We are likely to see a significant run up in debt to GDP ratios!

With respect to flows and financing, there are three main sources of flows.  The first is revenue related, the second is debt/equity issuance, the third new bank financed loans.

The first, the revenue reallocation from reducing investment (GFCI) assumes that enhanced profits or wages, within the existing out of balance industries, will result in higher consumer expenditure in other areas to offset the losses in GFCI.  The rebalancing here assumes that the reduction in GFCI plans result in a net gain through new service sector/consumption expenditure, incomes, jobs and investment.  But we also need to acknowledge that where there has been excess investment leading to excess capacity, that many of those productive entities may themselves cease to exist, or may need to reallocate flows to debt repayment.  In a sense for reallocation to work at source level we need a smooth natural transition without abrupt adjustment for imbalances.  As discussed this may require a not insignificant support operation.

The second, debt and equity issuance: with reduced GFCI in manufacturing and infrastructure, debt issuance in consumption service based industries will need to expand.  In a sense, we still require investment, just a switch.  These new industries require a level of stability in demand and incomes to phase the transition.  They also require a level of stability in the value of existing investment assets, in particular those assets that have financed recent capital expenditure in sectors that may now be attracting fewer flows.  So we need stability in employment in existing industries and a stability in the value of assets representing existing industries.   Transferring out of existing debt and equity investment (i.e. reallocate from old manufacturing and GFCOI I to new consumer focussed I) is not a realistic option, which means a reduction in preferred cash allocations and an increase in debt and equity allocations of consumption focussed service industries.  At the margin, most definitely, there would be leeway, but I do not think we are looking at a slow marginal rate of transition here, especially given all the transitional support.

The third, new loan growth, is a complex one and it may be that this will be the preferred route for expanding service and consumption sectors.  Will loan growth initially rise or fall as the focus of activity switches from manufacturing and investment to consumption and services.  Consumption growth requires higher wage growth, a tighter labour market and ultimately higher loan growth providing income growth and employment growth are positive.  A successful switch effectively implies greater capacity constraints.  What we do not know is the extent to which current service and consumption focussed economic activity is latent within current income levels: what I mean is that there may be a natural demand growth from current income levels that are restrained by the very fact that outlets for service demand are limited.

So transitioning is not easy and requires coordination at the best of times.  But the risks of transition are elevated principally because of the exacerbated imbalances in the Chinese and global economy (that started circa late 1990s) and the accommodations that both have made in response to the 2007/2009 financial crisis.  Is China’s one party system and the existing economic and financial structures capable of pulling this off even if it wanted to?  Again, the issue is the ease and speed of the transition and while China has much potential the barriers to a smooth transition and risks of discontinuity are many.

Post 2008 we have seen a clear failure by China’s authorities to rebalance the economy and the most recent economic downturn a particularly concerning one at that.  The dynamics of transition are becoming clearer and the risks more pressing.  From rapidly accumulating debt, from slowing growth, to the financing issues of its banking system and the development of a large shadow banking one, to the need for an overhaul of much its competitive economic architecture, to the limits of a centralised one party state, to the imbalances in capital investment and the over reliance on the real estate sector, to the innumerable environmental and human rights issues, China may well have come to a a key intersect.

China clearly has long term potential, but first it may have to bite the bullet, whether it wishes to or not, and this is a particularly difficult pill to swallow in a world heavily dependent on a much quicker transition.   I expect we will be soon be able to look forward to significant intervention in the Chinese economy and financial markets, just as we have seen in the US, Europe and Japan.


Global dollar credit: links to US monetary policy and leverage

Moody’s raises red flag over China’s public finances

Moody’s Investors Service notes that China’s regional and local government (RLG) debt pile grew by more than one-third between June 2013 and end-2014, citing official data. In the 18 months between June 2013 and end-2014, RLG debt rose to 24 trillion yuan ($3.7 trillion) from 17.9 trillion yuan, according to government statistics published over the weekend. Twenty-four trillion yuan is equivalent to 38 percent of the country’s gross domestic product (GDP) in 2014, according to Moody’s. Moody’s underlying concern is that debt levels are rising against a backdrop of falling revenues, potentially making it more difficult for RLGs to fulfill their repayment obligations.

Between January and July 2015, China’s slower growth rates lowered the RLGs’ budget revenue growth to 9 percent from 11 percent during the same period in the previous year.

“Seven provinces experienced falling revenues, 18 saw single-digit revenue growth, while only six achieved double-digit revenue growth,” Moody’s said.

Incorporating central government debt of 9.6 trillion yuan, and about 5.1 trillion yuan of “other” debt -such as that of railway companies and asset management companies – the bank (Nomura) estimates overall government debt at about 60.8 percent of GDP as of end-2014–PR_333779

Global economy survives the China and commodity shocks – so far September 2015

China adopts local government debt ceiling 30 Aug 2015

Inside China’s Tower Of Debt——-Eight Charts Which Track Its Borrowing Binge – Sept 2015

Is This The Great Crash Of China? Aug 2015

CHINA’S DEBT DILEMMA Deleveraging While Generating Growth September 2014

……the government has the “fiscal space” in the form of discretionary fiscal and financial resources to bail out the more important distressed state enterprises and local authorities and to recapitalize major banks. This will ensure that any tensions do not turn into the sort of systemic financial crisis that derails the economy. The process, however, will be messy and costly as the economy slowly hemorrhages financial resources in supporting these bailouts and is forced to throw good money after bad to keep growth in line with official targets.

China’s desperate need for a new round of financial, fiscal, and structural reforms to slow the growth of bad debt, put the finances of local governments on sound footing, and encourage productivity growth.

In most countries that have experienced a financial crisis, the credit surge has typically been the culmination of a long-term and broad-based deterioration in financial and fiscal indicators. China simply does not fit that pattern notably in its strong balance of payments, modest fiscal deficits, and high household savings rates.

By 2010 the worst of the crisis seemed to be over and the government scaled back bank lending by about a third. But shadow banking or nonbank lending through entities other than government institutions and informal channels quickly emerged to fill the gap, and by 2012 nonbank credit accounted for 40 percent of new credit, more than double its share before the crisis (see figure 1).

Why is China finding it hard to fight the markets?  Breugel 31 August 2015

All in all, China’s public debt today is above 53% of GDP, according to the National Audit. This may look small by international standards, especially in the developed world, but the rate of debt growth is unmatched elsewhere, and is even higher than Japan with its recurrently large fiscal deficits.

In fact, corporate debt has doubled as a percentage of GDP in the last 14 years. Beyond the stock of debt, its service is becoming an issue for corporations as the Chinese economy decelerates and their revenues are on the wane. Taking a very simple measure of stress in debt service, the ratio of EBITDA to interest expense has been below 1 for about one third of Chinese domestically-listed corporates, implying that their operating cash flow was insufficient to service their interest payments. This is especially the case for private ones.

Given that banks’ balance sheets have not been able to accommodate the borrowing from both the public and the private sector, a significant share of the corporate sector, especially smaller corporations, has increasingly used the shadow banking sector to meet their financing needs and circumvent tightening regulations on bank loans (Graph 5). This hardly regulated part of the financial sector now constitutes nearly 30% of GDP, with a good amount of inherent risk.

the FED quantitative easing coupled with a cheap dollar and the expectation of continuous RMB appreciation made it even easier to borrow from overseas and, to a large extent, from international banks. In fact, the exposure of Chinese banks and corporates to dollar debt has ballooned in the recent years, only correcting very recently in anticipation of FED hikes and the recent RMB depreciation

All in all, China’s total debt was 284% of GDP a year ago and, given the still large fiscal deficits and the leverage-fed stock market bubble – it seems likely that it may have reached 300% of GDP today.

China Growth Tracker, World Economics – September 2015

The path to sustainable growth in China – April 2015

…much of the investment that China has undertaken in recent years has been financed through loans provided by state-owned banks, raising concerns about the emergence of nonperforming assets on the books of the large state-owned banks if these investments turn out not to be commercially viable. Investment-led growth meant that employment growth, which has averaged less than 1 percent a year over the last decade, was relatively muted compared to the fast pace of output growth. This pattern of growth also has deleterious environmental consequences.

…..weak employment growth and high investment growth had resulted in labor income falling as a share of national income and personal disposable income falling as a share of GDP. The government has also been trying to channel more bank credit towards the services sector, which has the potential to provide more employment.

China’ s Debt: A ticking time bomb June 2015

Made in China 2025: A New Era for Chinese Manufacturing Sept 2015

China’s economy: no collapse, but it’s serious, and so are the politics September 2015

A moral deficit, The Economist October 2014

Liquidity evaporates in China as ‘fiscal cliff’ nears March 2015

The Chinese tax system is highly leveraged to the property cycle, like Ireland’s before the boom broke in 2007. The scale is epic. A study by the US Federal Reserve found that property investment in China has risen from 4pc to 15pc of GDP since 1998. This is even higher than in Japan in the blow-off years of the late 1980s.

The Great Rebalancing, McKinsey 2010

Debt and (not much) Deleveraging McKinsey 2015

Rebalancing and long term growth September 2013

Capital controversy, Economist , Apr 2012

China’s investment/GDP ratio soars to a totally unsustainable 54.4%. Be afraid. Jan 2014

Post 2008’ China looks a different animal. Productivity and efficiency seem to be plummeting, where GDP growth is becoming dangerously reliant on the ‘inputs’, namely soaring investment. We’ve all heard about how China’s leaders desire a more sustainable growth model, featuring a rebalancing of China’s economy away from investment and export dependence and towards one that is more reliant on domestic demand and consumer spending (e.g. see the 12th 5 year plan covering 2011-2015 or the Third Plennum). In practice, what we’ve instead consistently seen is an inability or unwillingness to meaningfully reform, where any dip in economic growth has been met with yet another wave of state-sponsored overinvestment.


China’s Rebalancing: Lessons from East Asian Economic History October 2013

This paper examines the earlier development experiences of Japan, South Korea, and Taiwan in order to shed light on the questions of whether China really needs to rebalance towards consumption and how it might be accomplished. The earlier developers had high investment rates peaking around 35% of GDP. Starting at about the level of per capita GDP that China has now, they all experienced a tapering off of investment. In general they rebalanced towards external demand which was possible because they had trade deficits in their rapid growth phases, which could then shift to trade surpluses. China differs from the earlier developers in several key dimensions. In recent years it has had 15-20 percentage points of GDP less in household consumption than the others; its investment rate has been noticeably higher; and it developed trade surpluses at an earlier stage of development.

In the past 20 years there has been adjustment in China away from household consumption towards both investment and exports. Rapid growth of exports stimulated investment, which in turn provided the capacity to produce more exports. This has been an effective growth model for China, but the problem now is that it has run out of steam. It is not plausible for exports to grow at the rates of the past decades now that China is the largest exporting nation; and the high investment rates and diminishing returns of recent years raise risks of over-capacity throughout the economy. The option that is left is to rebalance away from both investment and exports towards consumption.

There are four key institutional features of China’s post-reform growth model that can account for the differences in China’s development experience, compared to neighbors that have many cultural and geographic similarities: (1) the hukou registration system that limits rural-urban migration; (2) the large role of state enterprises in the economy; (3) the repressed financial system; and (4) the reward system for local officials within the ruling Communist Party. These are all areas in which there is active, current debate about reform.

Unproductive production, Economist, October 2014
China’s incremental capital-output ratio (ICOR), a measure of how much investment it takes to achieve each percentage point of growth, rose to 5.4 in 2012 from 3.6 over the preceding two decades, according to the World Bank.  Japan, South Korea and Taiwan were far more efficient during their high-growth phases, with ICORs of 2.7-3.2.


Distortions: why China is the new ‘old’ Japan August2015

China reforms hukou system to improve migrant workers’ rights July 2014

China’s Misleading Economic Indicators August 2014

Beyond capital and labor The view from China’s productivity frontier 2014

However, the country now faces a pair of major bottlenecks. First, its population is rapidly aging, and the size of the labor force is likely to plateau by 2016. Second, the pace of capital investment growth is expected to slow as Beijing seeks to rebalance the economy in favor of more consumption.

Conference Board Database –

An alarming result from this year’s estimates in The Conference Board Total Economy DatabaseTM is that the growth rate of total factor productivity (TFP), which measures the productivity of labor and capital together, continues to hover around zero for the third year in a row, compared to an average rate of more than 1 percent from 1999-2006 and 0.5 percent from 2007-2012. The challenge on TFP growth is widespread across the globe. Most mature economies including the United States, the Euro Area and Japan show near zero or even negative TFP growth. In China, TFP growth has turned negative, and in India it is just above zero, at 0.2 percent. Both in Brazil and Mexico TFP growth continues to be negative, respectively at -2.3 and -1.7 percent.

And productivity data:

OECD Economic Surveys CHINA March 2015

Excess capacity has been plaguing various industrial sectors, weighing on profitability and on capital spending in steel, cement, aluminium, flat glass and, downstream, electrical and railway equipment. Firms, including many SOEs, are driving down prices to secure market share at home and abroad. Falling prices of industrial products and inputs have kept core inflation subdued (Figure 4), notwithstanding labour shortages and resulting strong wage growth….monetary transmission through interest rates is not very effective, which in turn reflects that borrowers are mostly SOEs or sub-national governments

Grasp the large, let go of the small: The transformation of the state sector in China March 2015

China’s economic slowdown: 11 things you should know Sept 2015

The Second Phase of Global Liquidity and Its Impact on Emerging Economies Nov 2013

If we don’t understand both sides of China’s balance sheet, we understand neither Sept 2015

Financial Stability Risks, Old and New BIS, Dec 2014

China’s financial leasing firms report growing assets Sept 2015


China’s money supply surges but all is not what it seems August 2015


The simple arithmetic of China’s growth slowdown Feb 2015

Domestic Content in China’s Exports and its Distribution by Firm Ownership 2014


China’s Shadow Banking Sector Collapsed in July & China shadow banks appeal for government bailout August 2015


Chinese Exports in Numbers March 2015


China’s Shift to a Consumption-Driven Economy Nov 2014


China’s Economic Rise: History, Trends, Challenges, and Implications for the United States  June 2015

In its 2013 Global Manufacturing Competitiveness Index, Deloitte (an international consulting firm) ranked China first in manufacturing in 2013 and projected it would remain so in five years (the United States ranked third in 2013 and was projected to rank fifth in 2018). The report stated that “China’s competitiveness is bolstered by conducive policy environment either encouraging or directly funding investments in science and technology, employee education and infrastructure development,” and further stated that “the landscape for competitive manufacturing is in the midst of a massive power shift, in which twentieth-century manufacturing stalwarts like the United States, Germany and Japan will be challenged to maintain their competitive edge to emerging nations, including China.”

China’s trade and investment reforms and incentives led to a surge in FDI beginning in the early 1990s. Such flows have been a major source of China’s productivity gains and rapid economic and trade growth. There were reportedly 445,244 foreign-invested enterprises (FIEs) registered in China in 2010, employing 55.2 million workers or 15.9% of the urban workforce. As indicated in Figure 9, FIEs account for a significant share of China’s industrial output. That level rose from 2.3% in 1990 to a high of 35.9% in 2003, but fell to 25.9% as of 2011. In addition, FIEs are responsible for a significant level of China’s foreign trade. In 2014, FIEs in China accounted for 45.9% of China’s exports and 46.4% of its imports, although this level was down from its peak in 2006 when FIEs’ share of Chinese exports and imports was 58.2% and 59.7%, respectively, as indicated in Figure 10. FIEs in China dominate China’s high technology exports. From 2002 to 2010, the share of China’s high tech exports by FIEs rose from 79% to 82%. During the same period, the share of China’s high tech exports by wholly owned foreign firms (which excludes foreign joint ventures with Chinese firms) rose from 55% to 67%.

According to the World Bank, “China has become one of the world’s most active users of industrial policies and administrations.” China’s SOEs may account for up of 50% of non agriculture GDP. In addition, although the number of SOEs has declined sharply, they continue to dominate a number of sectors (such as petroleum and mining, telecommunications, utilities, transportation, and various industrial sectors); are shielded from competition; are the main sectors encouraged to invest overseas; and dominate the listings on China’s stock indexes. One study found that SOEs constituted 50% of the 500 largest manufacturing companies in China and 61% of the top 500 service sector enterprises. It is estimated that there were 154,000 SOEs as of 2008, and while these accounted for only 3.1% of all enterprises in China, they held 30% of the value of corporate assets in the manufacturing and services sectors. Of the 95 Chinese firms on the 2014 Fortune Global 500 list, 82 were identified as having government ownership of 50% or more. The World Bank estimates that more than one in four SOEs lose money.

China’s banking system is largely controlled by the central government, which attempts to ensure that capital (credit) flows to industries deemed by the government to be essential to China’s economic development. SOEs are believed to receive preferential credit treatment by government banks, while private firms must often pay higher interest rates or obtain credit elsewhere. According to one estimate, SOEs accounted for 85% ($1.4 trillion) of all bank loans in 2009…..the government sets interest rates for depositors at very low rates, often below the rate of inflation, which keeps the price of capital relatively low for firms. It is believed that oftentimes SOEs do not repay their loans, which may have saddled the banks with a large amount of nonperforming loans. Some contend these measures could further add to the amount of nonperforming loans held by the banks. Many analysts contend that one of the biggest weaknesses of the banking system is that it lacks the ability to ration and allocate credit according to market principles, such as risk assessment.

Local government debt is viewed as a growing problem in China, largely because of the potential impact it could have on the Chinese banking system. During the beginning of the global financial slowdown, many Chinese subnational government entities borrowed extensively to help stimulate local economies, especially by supporting infrastructure projects. In December 2013, the Chinese National Audit Office reported that from the end of 2010 to mid-year 2013, local government debt had increased by 67% to nearly $3 trillion.

Many Chinese firms, especially SOEs, do not pay out dividends and thus are able to retain most of their earnings. Many economists contend that requiring the SOEs to pay dividends could boost private consumption in China if the money was then used to help fund social welfare programs

McKinsey Global Institute predicts that over the next 50 years, China’s labor force could shrink by one-fifth. Some economists contend such factors will lead to much smaller rates of future economic growth. As the labor force shrinks, Chinese wages could begin to rise faster than productivity and profits growth, which could make Chinese firms less competitive, and result in a shift of labor–intensive manufacturing overseas. The one-child policy has also resulted in a rapidly-aging society in China. According to the Brooking’s Institute, China already has 180 million people aged over 60, and this could reach 240 million by 2020 and 360 million by 2030. The population share of people aged over 60 could reach 20% by 2020, and to 27% by 2030. With a declining working population and a rising elderly population, the Chinese government will face challenges trying to boost worker productivity (such as enhancing innovation and high-end technology development) and to expand spending on health care and elderly services.

Growing doubts about China’s economic growth August 2015

The experts also argue that China is undergoing a “clear cut housing bubble,” pointing to the size of real estate in the country as a share of its GDP. The figure, around 23 percent, is triple that of the US at its peak and similar to peak levels in Spain and Ireland, they said. The analysts added that the Chinese housing market is also oversupplied and overvalued.

A Hard Landing in China: Who Feels It Worst? Feb 2015

It’s fine, there’s plenty of China bubble fear for everyone July 2015

“China’s combination of a triple bubble (with the third biggest credit bubble, the biggest investment bubble and second biggest real estate bubble of all time)”

The size of real estate as a share of GDP: This is now triple that of the US at its peak and similar to peak levels in Spain and Ireland (Moody’s claim that real estate is around 23% of GDP, directly and indirectly);

Understanding Residential Real Estate in China April 2015

Real estate has been a key engine of China’s rapid growth in the past decade. Real estate investment grew rapidly from about 4 percent of GDP in 1997 to 15 percent of GDP in 2014. Residential investment, in particular, has been high compared with that in other countries. Today, it accounts for both about 15 percent of fixed asset investment and 15 percent of total urban employment. Bank lending to the sector accounts 20 percent of total loans. Real estate has strong linkages to several upstream and downstream industries (Liang, Gao, and He, 2006) and sales are also a key source of local public finance. Properties are extensively used as collateral for corporate borrowing.

Is China’s Property Market Heading toward Collapse? August 2014

The property market has become an important engine for China’s growth over the last decade. On average, property investment accounted for 20 percent of China’s fi xed asset investment (FAI) from 2004 to 2013, and residential property investment was about 14.1 percent of total FAI. In 2013, residential property investment alone directly contributed 0.8 percentage points to growth in 2013. However, the indirect impact of a property market slowdown on growth could be much larger, extending to a large industrial chain ranging from steel, construction materials and equipment, white goods, furniture, banking, and property-related services.

Adding to the fear of shadow banking defaults and the opaque funding relationship between property developers and China’s shadow banking sector, some market analysts have already referred to this period as the “end of China’s property boom,”

China’s mortgage finance industry did not exist until 1999. Mortgages outstanding are currently at slightly more than RMB10 trillion (USD1.6 trillion). Although this amount is growing fast, it remains a small portion of total bank loans, at around 14 percent in 2013. Given that China’s property market is still young, with limited institutional underpinnings and an inadequate regulatory framework, overshooting and irrational investment choices should be expected

China’s Slow Real-Estate Recovery Sept 2015


Rising fiscal debt. Continued fiscal policy support since the global financial crisis, manifested in the high augmented deficit, has brought the augmented government debt-to-GDP ratio to about 57 percent of GDP. While this is still manageable, with the rise in debt contained by the favorable interest-growth rate

A variety of indicators suggests that credit has risen to an excessive level. These include the Bank for International Settlements (BIS) credit gap measure and the high credit-to-GDP ratio in China relative to other economies at a similar income level (Box 3). The credit-to-GDP ratio is still growing, albeit at a slower rate given the recent slowdown in credit flow. Official banking indicators appear healthy, but there are reasons to believe they could weaken going forward. The nonperforming loans (NPLs) ratio—albeit still low at 1.4 percent—has been rising and the sum of NPLs and special-mention loans now constitute about 5.4 percent of GDP. There has also been a significant increase in disposals (26 percent of the gross stock of NPLs in 2014 compared to 18 percent in 2013). Loss-absorbing buffers in the banking sector, thus, could be eroded. Deleveraging and a further slowdown in the economy could reveal more problems with credit quality, especially in the SOE sector—SOEs account for the bulk of corporate liabilities and their performance indicators have weakened since 2008 (Figure 7). The equity market rally is another source of financial sector risk, especially given the increasing role of margin financing (Box 4).3 Global debt issuance by Chinese firms and their offshore subsidiaries has also increased considerably, but remains small relative to the stock of TSF and thus does not pose significant risks for financial stability (Figure 8).

Buildup of housing inventory. Years of very high real estate investment have resulted in considerable oversupply. Residential real estate investment—which accounts for more than two-thirds of total real estate investment—has been an important source of growth and employment, including by boosting activity in related industries. However, housing inventories have risen a lot, especially in smaller (Tier 3 and 4) cities, which on average have unsold supply of around three years of sales.

Toward internal and external balance by 2020. The staff baseline assumes that the Third Plenum blueprint is implemented by 2020 as announced by the authorities.4 Implementing these reforms—including social security, financial sector, fiscal, exchange rate, capital account, and SOE reforms—will reduce excess savings, lower investment, raise productivity, and boost consumption. The investment-to-GDP ratio declines as growth becomes less capital intensive and shifts to more laborintensive services. At the same time, reforms increase income and lower savings by households (with better social security and financial systems) as well as corporates (financial, SOE, and resource pricing reforms).

Avoiding the fiscal cliff. Staff advice is to keep the augmented deficit in 2015 broadly unchanged at 10 percent of GDP. Strict implementation of the new budget law could generate a sharp contraction in LG spending (‘fiscal cliff’) that would reduce the augmented deficit to well below 10 percent of GDP. This would have a large adverse impact on near-term growth, which should be avoided. Accordingly, the authorities have taken a series of measures to ensure that local governments can meet their ongoing financing needs, facilitating both the refinancing of maturing obligations and the funding of ongoing and new projects (by issuing LG bonds, extending bank loans falling due, and public-private partnerships—PPPs—for which new guidelines were issued in May). The staff recommends that a clear and comprehensive transition plan for LG financing under the new budget law be announced as soon as possible. The solution will need to find a balance between (i) preventing an abrupt contraction in fiscal spending; (ii) not undermining the budget law through excessive forbearance; (iii) minimizing moral hazard from rewarding imprudent borrowing by local governments; and (iv) limiting damage to the financial system from uncertainty and shifting the costs to banks.

Medium-term fiscal adjustment. Gradual fiscal adjustment should start next year, with a modest reduction in the augmented fiscal balance of around ½ percent of GDP each year. Over the coming years, the pace of adjustment could accelerate as the headwinds from reining in vulnerabilities dissipate and the benefits of structural reform take hold. The staff baseline assumes a gradual consolidation in the augmented deficit to around 8 percent of GDP by 2020. While augmented debt would continue to rise, it would peak at around 70 percent of GDP in 2020 (Appendix III). The structure of fiscal spending is also assumed to adjust in line with structural reforms to promote rebalancing, with lower investment creating room for higher on-budget current expenditures reflecting additional spending on health, strengthening of the social safety net, and bringing some of the legacy social security obligations on budget as discussed below.

China bank credit leaps and bounds from peers, BIS data shows June 2015

Debt and the financial cycle: domestic and global June 2014


Global Capital Flows From China Sept 2015

China’s Shadow-Banking Boom Is Over Dec 2014

Chinese Shadow Banking: Understanding KRIs and risk scenarios Jan 2014

The Rise and Fall of Shadow Banking in China Feb 2015

Shadow banking in China: A primer March 2015

Shadow Banking Is Killing China’s Stock Markets Aug 2015

The shadow banking paper that banks were floating could no longer go into real estate and infrastructure projects, because those were slowing down. They basically put the money into the stock market. They did it in a very leveraged fashion, similar to what happened in the United States with mortgages up to 2007. From one underlying pool of risk, you created a safer and a riskier tranche. And they’ve done something very similar in China. They make an equity investment, but they convert it into a structured product. The idea is that up to a certain return of the underlying stock, that becomes a fixed-return product, and anything above that is a variable-return product.

Kenneth Rogoff, economist who predicted eurozone crisis, has been warning the world about China for years Aug 2015

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