Long-term investment success, with trouble in the short term
In a column last week, Monitor argued that the mainland's investment boom is not as wasteful as Beijing's detractors believe.
The point is important, because people who believe the mainland economy is heading for a crash landing usually cite massive misallocation of capital to unproductive investment projects as the most likely cause of the impending crack-up.
They argue that the proof of this misallocation is to be seen all over the mainland in the form of empty airports, highways to the middle of the Gobi desert and entire ghost cities devoid of inhabitants.
Unconvinced by the anecdotal evidence, Monitor crunched the numbers and found that the amount of capital Beijing invests to produce each extra yuan of economic output has actually been pretty steady over the past 15 years (see the first chart). Despite the scare stories, Monitor concluded, 'the economic efficiency of China's investments is not deteriorating as the pessimists believe'.
Readers were sceptical. Some doubted the reliability of the original data, which is always a reasonable complaint in China. Some questioned the value of Monitor's investment-in growth-out indicator, or argued that the time periods chosen were too short to be valid.
Many gave examples from their own experience. 'Any old hand can tell you,' wrote one senior business executive, 'how much wastage there is in China'.
These are powerful objections, so it's comforting to see that Mark Williams, senior China analyst at independent research outfit Capital Economics, has attempted to answer the same question using different methods and come up with a similar answer.
'While most agree that China's investment-led economic growth model is unsustainable, there is no sign yet that it is about to implode,' he wrote in a report published yesterday. 'Most investment today is productive.'
Yet although most of today's investment projects may succeed in generating economic returns in the future, many will still cause big financial trouble in the near term.
The problem is the way they have been funded. Thousands of infrastructure projects have been financed with short-term bank loans to arm's-length funding vehicles set up by local governments.
No one knows exactly how much these funding vehicles have borrowed, but private sector analysts reckon the figure is around 14 trillion yuan (HK$16.8 trillion), or 35 per cent of gross domestic product.
According to analysts at HSBC, over 70 per cent of these loans have gone to finance long-term projects that will only begin to pay off towards the end of the decade (see the second chart).
Unfortunately, however, 53 per cent of the loans will mature by the end of 2013, and a further 17 per cent over the following two years.
As HSBC's China economist, Qu Hongbin, put it in a report published on Monday: 'It will be difficult for these projects to generate sufficient cash flows in the next three to five years to repay local loans.'
It will be difficult, too, for the projects' local government sponsors to support them with extra cash. As Qu says, debts falling due over the next couple of years are 40 per cent greater than the mainland's total annual local government revenue.
That leaves few options. The banks could roll local government debts over, carrying them as undeclared bad loans. But according to reports last week, that has been forbidden by the China Banking Regulatory Commission.
That means either the banks will have to write the loans off as they fall due and borrowers default, or Beijing will have to step in with some form of restructuring plan.
Writing off the loans would be painful for the mainland's banks and their shareholders. According to analysts at BBVA in Hong Kong, absorbing the 3 trillion yuan cost would force the banks to raise an extra 700 billion yuan in new capital on top of what they already need to maintain their capital adequacy ratios.
The other option is for the central government to orchestrate a bailout, either by taking local government debts on to its own books, or by allowing local governments to issue long-term bonds in their own right and to use the proceeds to repay their bank loans.
No doubt dyed-in-the-wool pessimists would regard such a bailout as simply sweeping local governments' bad debts under a very large carpet. But a problem deferred could be a problem solved. If the infrastructure projects funded by those debts do generate a decent economic return over the long term, then the mainland's overall growth rate should stay high enough to shrink the debts to a manageable size relative to GDP, at which point they can be written off without too much pain.
It's a trick that's worked before. Hopefully it will work once again.