Is China targeting the right enemy in its war on debt?
Hao Zhou says Chinese policymakers torn between spurring growth and pushing financial deleveraging should first differentiate bad debt from good – they should reform the state sector, but also provide help to ease companies’ cash flow
Things look familiar again. Due to financial deleveraging policies over the past two years, China’s economic growth has slowed significantly, although official GDP numbers still look decent. Indeed, the markets have flagged investors’ concerns about the economy.
For instance, the benchmark CSI 300 index lost 12.7 per cent in the first seven months of 2018. Ten-year government bond yields have experienced a free fall since the beginning of the year, which typically means risk aversion is dominating the market.
Chinese authorities have conducted a slew of easing measures since the second quarter, indicating that the downside risk to the economy has been intensifying. However, different from the past few easing cycles, the market remains sceptical about the effects of the new round of policy easing.
Certainly, trade tensions have dramatically worsened market sentiment, clouding China’s economic outlook. But what has really confused the market is how to spur growth while proceeding with financial deleveraging. In other words, what is the policy priority now?
Seemingly, even policymakers have no clue. The Politburo meeting presided over by President Xi Jinping on July 31 was widely seen a critical event which laid out the policy framework for the second half of the year. Unfortunately, it is difficult to figure out a workable proposal from the statements.
According to the official Xinhua news agency, fiscal policy should play a bigger role in expanding domestic demand, reflecting a bias towards easing. However, China will also maintain control of monetary supply and keep liquidity at a reasonable level.
Additionally, a firm stance should be taken on reducing the leverage ratio. Authorities stressed the importance of a well-coordinated unveiling of new policies, and also said the property market should be managed properly and the rise in home prices curbed.
Put simply, this is again a multi-pronged policy guidance. In past easing cycles, the economy stabilised when spending on property and infrastructure picked up strongly. However, things are trickier this time. In the first place, China has very limited room to stimulate its economy.
When China introduced its 4-trillion-yuan stimulus package in 2008, the country ran a sizeable current account surplus, which was about 9 per cent of gross domestic product. With debt piling up over the past decade, however, the current account surplus has shrunk to 0.5 per cent of GDP by mid-2018 (on a four-quarter rolling basis).
That said, if China gives up its deleveraging efforts and maintains its fiscal spending and property investment, it will soon reach a limit. The yuan is likely to experience a rapid depreciation if China becomes a deficit country.
At least for now, a rapid currency depreciation is not the way forward, as it could become the catalyst for a painful bursting of the asset bubble. Admittedly, financial deleveraging needs to continue, as it matters for China’s medium- to long-term development. However, if the government wants to prevent the economy from slowing further, financial deleveraging should be postponed or even redesigned.
Externally, China faces huge pressure from the United States on the trade front. All in all, it looks like China has little room to manoeuvre.
Beijing needs to think out of the box. Policymakers have to differentiate “bad debt” from “good debt”. That is, debt is not always a bad thing if a debtor can generate decent returns from the borrowing. If this principle were applied, the policy deadlock could be addressed more constructively.
For example, the government should provide tax relief to companies to improve underlying cash flows. In addition, some structural reforms, such as those targeting state-owned enterprises, should be pushed forward to help market access, increase Chinese companies’ competitiveness, and improve intellectual property protection to support technical upgrading.
Stimulus measures have their limits. Certainly, China’s growth outlook is challenging, as suggested by many economic indicators. But a policy recalibration will be helpful to figure out priorities. One thing is clear: the most successful policies should benefit most people.
Hao Zhou is senior emerging markets economist at Commerzbank