SOE REFORM
The View
by

2017 is China’s year of judgment

Time is running short to rein in debt, free the currency, reform the state sector, liberalize investments, or allow dud companies to go bust

PUBLISHED : Thursday, 05 January, 2017, 1:23pm
UPDATED : Thursday, 05 January, 2017, 10:48pm

You can promise so much for only so long.

Chinese economic growth has been falling continuously for over 8 years now. We have seen the hard landing and now the economy must begin to pick up – or people will talk.

Admittedly the slowdown has come from a high of 14.2 per cent in 2007 -- a golden year fuelled by debt and the red mist.

We know that no economy can grow at a rapid rate forever – especially one containing 1.3 billion souls. We also know that the GDP figures have been manipulated to flatter and smooth; never showing the true slowdown, and that makes it difficult to forecast a recovery.

But after so many years, the excuses run thin. The economy needs to improve. 2017 is Judgement Year.

The Xi Jinping administration has fought hard to earn a place at the top table of global superpowers. It has made many financial commitments along the way and a successful economy is key to sustaining that position.

Yet China is still spending borrowed money like a gambler spends his winnings. The huge sums pledged for the One Belt, One Road initiative are estimated at between US$4 trillion and US$8 trillion – much to be invested outside the primary economic regions of China.

For years, analysts have looked to future Chinese economic growth being with the domestic consumers and the technology sector. However, fixed asset investments in old, fragile, state-owned smokestacks is still growing over 20 per cent - with single digit returns.

Heavy infrastructure spending is only beneficial if questions are asked about why the money is spent. What on? How? What are the payback times? And how much is lost to corruption?

Even in the private sector, a company with admitted financial difficulties: LeEco, has just received US$1.4 billion -- as if by magic -- to keep its unstrategic businesses going.

HNA Group, the Chinese conglomerate, last month made no commercial sense in paying a massive 25 per cent over the very highest market valuations to buy land at Kai Tak.

China’s total debt to GDP ratio is a staggering 290 per cent according to McKinsey.

Debts have to be earned back somewhere. The Soviet Empire collapsed believing that money would always be there to spray around.

Life is likely to get harder. The Shanghai Composite Index closed 5.8 per cent lower even as the currency fell over 7 per cent last year.

Trying to keep the currency stable in the face of difficult economic conditions has encouraged expectations of further decline and big currency outflows, tightening liquidity at home.

Donald Trump has made nothing but conciliatory gestures towards Russia but only hostile comments towards China, as if stuck in some 2009 time warp. It will be tough to let the currency fall, as it should, when Trump is threatening to call out China as a currency manipulator.

Worse news is that China’s outbound investments rose by half in 2016 while inbound suffered a rare slowdown.

The Beijing Times spoke of auto glass manufacturer Fuyao Group investing $600 million in the U.S. because taxes and operational costs are now lower in the U.S. than in China.

The authorities were sparked into action last week to ease restrictions on foreign investment in “an orderly way” but it will take longer to ease foreign mistrust.

“We sense a growing tendency in China towards market closure and a favouring of indigenous production, ” the German ambassador to China Michael Clauss said in an interview with the South China Morning Post.

Managing a command and control economy requires taming asset bubbles and handling badly managed, unprofitable state companies at the same time.

The natural reaction by the authorities is to fight every setback, ever tightening rather than relaxing control. It makes things worse and (horrors!) you get blamed for everything that goes wrong. Free market economics means that you have to lose some economic battles, because you can’t win them all.

This column would not dare to tell smart Chinese policymakers what to do, but we can point out to investors what they should be looking for.

Time is running short to rein in of debt, free the currency, reform the state sector, liberalize investments, or allow unprofitable companies to go bankrupt, even in strategic areas.

At present, businessmen in China have no moral hazard preventing them from borrowing more and spending irrationally … even on football players.

It is almost too late for this to happen without a recession to clear the decks. Investors have to watch China closely in 2017.

The immortal message of policymakers everywhere holds just as true in China: “It’s the economy, stupid”.

Richard Harris is an investment manager, writer, broadcaster and financial expert witness. www.portshelter.com

business-article-page