As China transitions to a ‘new normal’, some financial, economic and political pain is inevitable
Andrew Sheng says Beijing will have to make some tough decisions this year to ensure the long-term goals of the 13th five-year plan are met
There are good reasons for being cautious. The foreign media’s analyses of the Chinese economy are almost uniformly pessimistic. Not only do they think there will be a hard landing, but several analysts think a financial crash is inevitable.
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The facts are quite clear on the risks. First, from 2008 to 2014, China’s private debt-to-GDP ratio rose by 73 percentage points. The famous 2009 book by Carmen Reinhart and Kenneth Rogoff, This Time is Different, suggested that fast-rising private debt is the best indicator of financial crises. In the past five years, Chinese debt has grown fastest in terms of total debt. Second, the economy is clearly slowing, with both manufacturing and service-sector indicators being negative or showing a slowdown. Third, since last July, despite market intervention, the stock market index is still signalling downwards. Bank of America Merrill Lynch analysts are predicting a Shanghai Composite Index level of 2,600 for 2016, compared with a peak of 5,178 last June and current levels of 3,100. Fourth, there are capital outflows and concerns on renminbi depreciation.
On the plus side, proponents argue that, so far, the labour market has remained resilient because of the shift towards a more labour-intensive service sector. Household consumption has remained fairly firm, while inflation has been flat, helped by lower commodity and energy prices.
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On the external front, the balance of payments current account remained a surplus at 2.1 per cent of GDP, which offset the capital outflows as indicated by the loss in foreign exchange reserves.
All these aspirations must be achieved within the context of social and financial stability. No economy in the world has attempted all these ambitious goals simultaneously without some trade-offs. In such a massive transformation in scale and short time frame, some economic, financial or political pain is inevitable.
Seen from this perspective, the key question for China is whether the economic trajectory is J or L-shaped. In other words, are the reforms aiming for a short correction followed by more sustainable long-term growth, or will China join the rest of the world in a global secular stagnation phase?
China’s debt problem is almost unique in that it is largely a domestic debt overhang, with state-owned banks lending mostly to state-owned enterprises with no net debt owing to foreigners. Since local governments and SOEs still own considerable net assets, now is the time to rewrite the national balance sheet with debt-equity swaps to cut back the debt and restore balance in the corporate leverage situation. The state-led system can deal with its state-driven debt problem.
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But one factor to consider in the current system is whether the political cycle is in sync with the economic cycle. The anti-corruption campaign, which is designed to restore integrity and trust in the cadre system, has now pulled in a number of businessmen, which creates uncertainty whether public and investor confidence can be “business as usual”.
The level of the stock market index is only an indicator of the complex mix of investor greed and fear. Just as GDP is no longer adequate as a benchmark of economic progress, policies and business decisions benchmarked against a stock market index can only be wrong.
Tough decisions will have to be taken in 2016 to ensure that the long-term aspirations of the 13th five-year plan can be achieved.
Andrew Sheng is distinguished fellow at the Asia Global Institute, University of Hong Kong