It is risky indeed for someone like me, on the other side of the world, commenting on a country with spotty economic data (a function of size and maturity of its information gathering apparatus, as well as possible intent to put lipstick on pigs) to take issue with an emerging consensus. Nevertheless, I will stick out my neck a tad.
Reports of China being on the mend, such as “China’s Economy Shows Signs of Recovery on Stimulus,” on Bloomberg are overdone. I suspect way overdone.
Consider some basics. China’s economy is not as export dependent as many believe, but exports have made a significant contribution to growth. Commercial real estate development has been another big driver. Those two have gone into reverse.
Let’s deal with the notion of “stimulus” making up for the slack. The famed half trillion dollar plus package announced some months ago was largely spending already budgeted and planned. Analyst views vary (and further input welcomed) but from what I have seen, only 1/6 to 1/3 was new spending, and most of that occurred in the second year of this two-year program.
The latest bit of news that the markets have seized upon is that China has been pushing its banks to lend, and loan growth has been impressive. However, Michael Pettis tells us that appearances are deceiving:
I have three very serious problems with the optimism associated with the latest numbers on credit expansion.
First, this credit expansion is not all that it may seem. Aside from the fact that a lot of this new credit has consisted of an increase in bill discounting, in order to understand what is really happening to total credit in the Chinese economy we need much better data. There are persistent rumors that part of the increase in bank lending consisted of putting back on balance sheet loans that were taken off balance sheets in 2007 and 2008 when the PBoC was trying to constrain bank lending. It isn’t really new credit…
What is more, there is clearly an increase in lending games aimed at making policymakers happy by showing fat loan books. One of my students just visited me today with an example that involved his father. I don’t want to get into too much detail, for obvious reasons, but the net effect of the transaction involving his father was that an entity was created to borrow money from a bank, the proceeds of which were deposited in a CD, which was then assigned in ownership to the real borrowing entity, which then used the CD as collateral for the “real” loan. Aside from the complications used probably to get around credit restrictions, one single loan was recorded as two loans plus a CD deposit. Apparently the lending bank knew about all the intermediate steps. Surprise, surprise! It turns out that if your career prospects depend on increasing the total amount of loans outstanding, with less focus on the quality or structure of the loans, in fact it isn’t hard to show very nice, fat loan book.
One of the readers of this blog, yesterday gave another very interesting example of what might be included in this new lending. He says:
As for the sudden surge in lending, this looks to me to be an accounting exercise, clearing or otherwise funding non-bank debts piled up by SOEs. Many large SOEs (not central ones, regional/local ones, though the central ones win no prize themselves) are behind on paying wages, suppliers etc, and the stimulus provided by this lending surge is really just to ease the log-jam of triangular debts. This implies that there will not be much “bang” for all of this lending
Second, exploding credit may provide a fillip to growth in the short term, but if it leads to a future increase in bad loans, it will have exactly the opposite effect in the near future. As I discuss in my previous blog entry, this represents a big bet on the duration of the slowdown.
Third, the biggest problem has to do with how much credit expansion will make a difference. Andrew Batson at the Wall Street Journal (sorry, I don’t have the link) makes this point when he discusses the “string of dire profit warnings has signaled a rapid deterioration in the financial health of Chinese companies.” His relevant paragraphs
Corporate investment is hugely important to China’s economy, where capital spending accounts for more than 40% of annual output, one of the highest ratios in the world. The profit decline will have major effects across the economy as companies have less money to buy new equipment or expand their businesses.
…Economists have long warned that Chinese companies’ heavy reliance on retained profits would tend to exaggerate swings in the nation’s investment cycle. Official statistics show that 63% of investment in China last year was financed by what are called “internally generated” funds, which include retained profits. That’s up from just below 50% a decade ago.
Basically Chinese corporate profitability in China is dropping sharply, and nearly everyone expects the trend to continue over the rest of 2009. If nearly two-thirds of investment in China was funded by retained earnings, a sharp drop in profitability should result in an equally sharp drop in investment funded by retained earnings. I don’t know the magnitude, but I would guess that a very large increase in real bank lending aimed at real investment, far more than has been reported, would be needed just to make up for the decline in investment out of retained earnings
Now that’s merely one man’s opinion, albeit a well informed one who is also on the ground.
Yes, the Chinese stock markets have rallied, but the US in the Great Depression had six rallies of over 20% on the way to its bottom. Some perkiness on the investment front isn’t conclusive.
If we look at the Great Depression for analogies, it was the manufacturing power and big FX reserve (in this case gold) accumulator, the US, that was one of the very worst hit by the Great Depression and had one of the hardest roads out. Admittedly, that was in part due to it being comparatively late to depreciate its currency. Trade deficit countries that defaulted on sovereign debts had much shallower downturns.
Perhaps most important, economic downdrafts are not linear affairs. There are upticks and down moves within an overall trend. But the optimists are eager to find signs of improvement and declare it a recovery.
China’s economy is showing signs that a 4 trillion yuan ($585 billion) stimulus package is taking effect.
The world’s third-biggest economy may expand 6.6 percent in the second quarter after slowing to 6.3 percent in the three months to March 31, the weakest pace since 1999, according to the median estimates of 14 economists surveyed by Bloomberg News…
“China looks set to be the first major economy to recover from the current global meltdown,” said Lu Ting, an economist with Merrill Lynch & Co. in Hong Kong. “China is the only economy in the world to see significant growth in credit to corporate and household sectors after September 2008, when the financial crisis worsened to a near collapse.”
The government’s stimulus plan, announced in November, is beginning to gather momentum. Projects such as the building of 3.5 billion yuan of public houses in Shaanxi province and Shanghai began in December, while Shandong province started work on three new railway lines the same month….
Even if the global recession is protracted, China has the ammunition to maintain growth, said Merrill Lynch’s Lu. It has public debt of only 18.5 percent of gross domestic product — compared with 75 percent in India — foreign currency reserves of $1.95 trillion, and a balanced budget.
“China has perhaps the deepest pockets in the world,” said Lu. “It can relentlessly ramp up spending to create jobs and meet its growth target.”…
“The economy is bottoming,” said Tao Dong, chief Asia economist at Credit Suisse AG in Hong Kong, citing the PMI, the surge in bank lending, and spending on construction and machinery because of the infrastructure projects….
Companies fired workers at a faster pace in January than in December and most businesses faced tougher conditions, said Stephen Green, a Shanghai-based economist at Standard Chartered Bank. “Less bad news is not good news,” he said.
Even if stimulus spending creates 8 percent growth this year, meeting the government’s target, “it will unlikely be healthy, job-creating growth” because mostly it will boost demand for steel and cement and provide little support for consumption, said Green.