Across The Border

Analysts raise red flag as China’s state sector reverses nearly 20 years of declines in the share of economy

Latest figures show the contribution made by SOEs to the Chinese economy rose for the first time since late 1990s

PUBLISHED : Monday, 28 November, 2016, 5:45pm
UPDATED : Monday, 28 November, 2016, 9:37pm

Although China’s economic growth is widely expected to hit its annual target of 6.7 per cent for 2016, some observers fear it could start heading in the other direction, as a bloated state sector reverses nearly 20 years of declines, to raise its share of GDP, while private investment growth remains stagnant.

The latest government statistics show that the contribution made by state-owned enterprises to the Chinese economy rose for the first time since late 1990s.

The China Statistics Year Book 2016, released earlier this month, shows the economic contribution of state-owned enterprises (SOE) in the industrial sector increased to 38.83 per cent in 2015 from 38.81 per cent in 2014 – reversing nearly 20 years of declines.

This year’s statistics are yet to appear, but other data too has indicated the state sector continues to grow.

The latest readings from the National Bureau of Statistics revealed fixed-asset investment by the state sector jumped 20.5 per cent on-year in the January-to-October period, while private investment nudged up 2.9 per cent.

At the same time, worryingly, capital efficiency in the state sector has also worsened.

Investment returns in the state sector declined sharply to 2.9 per cent in 2015 from 3.9 per cent in 2014, the lowest level since 2000.

“Private investment growth almost came to a halt this year, while state sector spending increased sharply. This represents huge risk to the Chinese economy,” said Zhao Wei, an economic professor at Zhejiang University, in a recent research report.

Since state investment is usually viewed as low efficiency, “it’s unrealistic to count increases in investment efficiency as a driver of GDP growth this year,” Zhao said.

Instead, China’s economic growth seems to have become more reliant on input, namely rapid investment.

“However, improvement in efficiency is critical to sustainable economic growth in the long term,” he added.

“The advance of the state sector at the cost of the private sector is a major setback,” said Ren Zeping, an analyst with Founder Securities, in a separate research note.

He said the main reason behind China’s rapid economic growth since the reform and opening-up in 1978 has been to improve efficiency of resource allocation, driven by a retreat of the state sector and advance of the private economy.

“In recent years, however, many money-losing SOEs have become so called ‘zombie firms’, becoming fully reliant on financial support from local governments, while profitable private companies have faced discrimination in financing and industrial access, which has forced many out of business,” Ren said.

“This is a step backwards for China,” he said.

This has also led to a surge in speculative buying in the property and stock market, and an exodus of capital, said Zhao from Zhejiang University.

Many money-losing SOEs have become becoming fully reliant on financial support from local governments, while profitable private companies have faced discrimination in financing and industrial access, which has forced many out of business. This is a step backwards for China
Ren Zeping, an analyst with Founder Securities

“Private money hardly has anywhere to go. So the vast majority of it is flowing into real estate, the financial markets, or fleeing overseas.

In Zhejiang province, considered one of the most vibrant in the country, private investment accounted for 80 per cent of total real estate investment in the first three quarter of the year.

Jiming Ha, chief investment strategist for China at Goldman Sachs’ private bank unit, told an seminar earlier in the year that China’s economy is “more distorted and imbalanced than Japan was in the 1970s and Korea was in the 1990s”, with the highest share of fixed-asset investment in the world at the moment of around 45 to 46 per cent.

He warned the economy could face the worst-case scenario of what he dubbed an “economic avalanche” in 2018 to 2019, which would be triggered by a potential debt crisis.

“China has a serious problem of economic imbalance, manifested by a high proportion of investment in the economy,” Ha said.

“It’s SOEs absorb that resource – but they actually do not make money, if we exclude huge government subsidies in the forms of cheap financing and low resource costs,” he said.

The issue, coupled with overcapacity, environmental challenges, and working-age population problems, is going to seriously drag China’s economy in the coming years, he added.

“The working age population has already hit breaking point and will shrink rapidly in future years.

Without any foreseeable breakthrough in technological progress in the short term, the Chinese economy is inevitably going to slow down over the next few years,” Ha said.

He said the worst scenario is the economy is hit with a shortage of credit, which could spark a sharp depreciation in the currency, massive capital flight, a surge in interest rates and a slump in real estate prices.