How debt threatens to undermine China's growth miracle
Gene Frieda says just as termites can undermine the foundations of a building, so local government debt is threatening to fundamentally destabilise an economy that is already slowing
There is no better metaphor for the economic challenge that China is facing than the futuristic architectural masterpiece designed to house China Central Television, the state network. On February 9, 2009 - a few months before the landmark building was to be completed - network officials conducted an unauthorised fireworks display, sparking a fire that consumed a smaller building in the complex, a wedge-shaped tower that Beijing's residents had nicknamed the Termites' Nest.
The fire delayed the completion of the CCTV headquarters until 2012. The Termites' Nest remains unfinished and unoccupied; its structural integrity was destroyed in the fire, and it cannot be torn down for fear of undermining its big neighbour.
The two buildings recall China's increasingly two-tracked economy: a new track based on services and consumption burdened by an old, slower track made up of industries such as steel and mining, which are inefficient and suffer from excess capacity. Straddling both tracks is the country's real-estate market, characterised by massive overcapacity in small and mid-size cities and robust demand in large ones.
The real wake-up call has been the belated effort to sort out local government borrowing and misspending
The problem is compounded by the Chinese leadership's insistence on sticking with high growth targets - 7 per cent at present - and the resulting reliance on credit to produce the requisite output. Because the credit system has been designed around implicit state guarantees, much of the financing is misallocated to the less efficient, highly indebted economic sectors. As a result, the foundations of China's growth miracle are steadily being eroded by a debt overhang that shows few signs of receding.
The government's loss of control over the economy has become increasingly evident. The meteoric rise and then crash in the stock market has left investors rattled. But the real wake-up call has been the belated effort to sort out local government borrowing and misspending.
The National Audit Office's first attempt to estimate the size of local government debt uncovered a stock worth 26 per cent of gross domestic product at the end of 2010. It was 32 per cent of GDP in mid-2013, and the latest study by the Chinese Academy of Social Sciences shows that the debt had jumped to 47.5 per cent of GDP by the end of last year.
In November 2013, President Xi Jinping laid out a reform agenda that sought to increase the role of the market in China's economy. This, it was hoped, would solve the capital misallocation problem that seemed to be leading to an unsustainable rise in debt.