All signs point to an economic slowdown in China, but warnings of a credit crisis are too simplistic
Joe Zhang says a recession would be a much-needed shock to achieve the transition Beijing seeks to a domestic-consumption-led growth model
For the past four years, analysts at Fitch Ratings and Wall Street banks have shared a consensus: a credit crisis will break out in China at any time. Their prediction was based on two factors: China’s economy was slowing sharply, and bad debts would lead to bank runs. Above all, the country’s debt-to-GDP ratio was alarmingly high and climbing. But, four years on, a credit crisis seems a more remote possibility.
Look at the current situation: China’s banks are still very liquid; loan growth has stayed at a 10 per cent clip; public confidence in the banks is unquestioned; and external debts are manageable.
It is true that the number of officially reported bad debts may be only a fraction of the actual figures. It is also true that some banks may be running on a very low or even negative equity as their bad debts may have wiped out their capital cushion. But does that really matter? Capital cushions are there to be wiped out, by design. In bad times – like today – capital gets depleted, and come the good times, the banks will make a killing and build the cushions again. Even in bad times such as these, China’s banks continue to pay very high dividends despite analysts’ constant talk of rising bad debts and thin capital cushions.
And, it is worth highlighting that non-bank financial institutions in China have fared much worse in the current economic downturn. A large number of crippled microlenders, and failed trust companies, guarantee companies and even leasing companies litter the landscape. And it is easy to see why, since their cost of input (that is, funding cost) is the banks’ cost of output. In other words, they not only operate in a subprime sector but they are also at the mercy of the banks. Securities firms (dealer-brokers) are now also becoming risky lenders in the already inflated A-share market while the insurance sector is slowing. Some analysts argue that, compared to the US or Europe, market penetration of China’s insurance services is very low and that it has huge growth potential. But in the short to medium term, the sector looks overserved and wildly competitive.
A slower economy is the cause of banking distress in China and parts of Europe. But if the governments of Italy, Greece, Portugal and Spain had China’s kind of total freedom in setting fiscal and monetary policies, their own banking sector distress would be much easier to manage.
Since this kind of banking distress, in most cases, is a reflection of a slower economy, it is natural to wonder how Beijing is going to boost growth. I think the government, knowingly or unknowingly, is experimenting with just how much of an economic slowdown the country can tolerate. Beijing is clearly not priming the pump as much as it is capable of doing.
The last stimulus in 2008 has now been badly discredited and there is no appetite for a repeat of that scenario. Thankfully, labour market pressure is mild, after the 35-year cycle of family planning which has ensured that workers are not flooding the marketplace. So it is safe to say that China can afford to slow down much more, as the economy appears resilient enough.
So what do we make of supply-side reforms? Sadly, I believe the push for reforms is mostly lip service at present since Beijing is not cutting taxes, red tape is still a big headache, and state-owned enterprises, instead of being sold or downsized, are regaining dominance at the expense of private-sector rivals.
Rural land reform is unfolding slowly. Farmers need the reform to benefit from economies of scale, and to be able to use their land as collateral for bank credit. It is safe to expect the market value of rural land to rise significantly on the back of the reforms. This is long overdue, as the country’s economic growth and asset price inflation of the past two decades have left farmers far behind city residents.
Overall, China’s economy is probably not growing at present, judging from power consumption and transport volumes. But it is a blessing in disguise. A recession is a much-needed shock if China wants to transform its economy into one led by domestic consumption. In such a transition, banks would suffer enormous pain, obviously, but it is far too simplistic to predict a banking crisis.
Joe Zhang is the chairman of China Smartpay Group, and a former manager at the People’s Bank of China