China ramps up spending as the trade war bites, adding to the burden of its long-term debt
Cary Huang says China’s solutions, both to the US trade war and its slowing growth, are worsening a debt problem leaders had been determined to address this year, and which looks likely to be a long-term drag
Governments use economic stimulus packages to boost growth and lead an economy out of a recession or slowdown, even though the interventionist policy has been controversial since its birth. Governments use expansionary monetary and fiscal policies as their two main tools.
But the trade war has come at the worst time for China. The government has less leeway to stimulate the economy through monetary or fiscal measures, as the economy is already slowing and the government is struggling to reduce the debt burden amid a very big debt overhang.
The short-term effects of the trade war have already inflicted pain on Chinese asset and currency markets, triggering panicked sell-offs of Chinese assets and the currency in the past three months. China’s stocks have entered bear market territory, losing more than 30 per cent since the peak in January. The yuan has seen an 8 per cent decline from its March peak.
The long-term impact is that uncertainty is likely to lead to sweeping diversification or substitution among consumers and suppliers in the well-established supply chain. As a result, assembly lines will move away from China, and business orders will be shifted to other countries, which will deal a deadly blow to the future growth of the export-oriented economy.
That is why a recent Politburo meeting called for prioritising growth and adopting a more accommodative monetary and fiscal policy, signalling an end to the year-long deleveraging campaign. The tone of monetary policy changed from “stable and neutral” to “stable”.
Deleting the word “neutral” signals a major shift towards a more aggressive monetary policy to support growth, rather than focusing on deleveraging. This is being adjusted to a more selective “structural deleveraging”. Until recently, the government had made cutting debt its overriding priority, and focused on the elimination of zombie firms and restructuring indebted or loss-making companies.
To implement the Politburo decision, the cabinet has unveiled plans to speed up fiscal spending. The State Council promised to ramp up the raising and spending of 1.35 trillion yuan (US$196 billion) on infrastructure. It pledged an ambitious tax and administrative fee-reduction plan to reduce at least 1.1 trillion yuan in burdens for enterprises this year. The People’s Bank of China has cut the reserve requirement ratio three times, to increase the money supply this year, in defiance of the US Federal Reserve’s monetary tightening.
The policy change provides growing evidence that officials are concerned about how the trade war with the US could exacerbate a domestic slowdown. But many economists fear that the expansionary policy will stoke a further build-up in debt. The world’s second-largest economy has become more vulnerable in recent decades because the economic growth has been underwritten by an even faster increase in debt.
The country’s gross debt – both public and private – is now estimated at over 250 per cent of gross domestic product. Moody’s and Standard & Poor’s both downgraded China’s sovereign debt credit rating last year because of concerns about the debt overhang.
The loosening monetary policy will weigh on the yuan’s value amid an outlook of higher US interest rates, which is likely to trigger a new round of capital flight and inflict further pain on bearish asset markets.
Beijing faces a challenge on how to maintain a delicate balance between growth, stable markets and debt reduction.
Historical experience suggests that, while stimulus measures might provide short-term momentum, they also have long-term negative effects on the health of an economy (witness China’s infamous 4 trillion yuan stimulus during the 2008-2009 financial turmoil), when politically motivated projects resulted in overcapacity in some industries and a build-up of bad debt.
Cary Huang is a senior writer at the Post