China’s
Debt Bomb
A
Towering Chinese Debt Mountain Looms Over Markets
Enda Curran
January 14, 2016 —
Lost
in all the Chinese stock and currency market gyrations, policy
missteps and mixed data is this economic reality: The government is
constrained by a credit bubble that has ballooned to $28 trillion in
an economy growing at its slowest pace in 25 years.
Policy zig-zags have
left investors divided over how wedded President Xi Jinping and
Premier Li Keqiang are to financial sector reform and shifting their
$10 trillion-plus economy from one powered by investment and exports
to one more focused on consumption and services.
China has appeared
to backtrack on pledges to make its management of the yuan more
market driven and there’s uncertainty over the government’s
willingness to remove stock price supports imposed during a $5
trillion sell-off last summer. Amid the confusion, the benchmark CSI
300 Index, down 14 percent in 2016, has revisited the lows of last
year’s rout and pressure on the currency continues.
Against that
backdrop, Chinese officialdom faces the high-wire act of trying to
keep the economy growing rapidly enough to repay past obligations,
without resorting to a fresh pick-up in debt to fund more stimulus.
It was China’s reliance on credit-fueled growth in the wake of the
2008 global financial crisis that resulted in one of the biggest debt
expansions in recent history, and today’s hangover.
"China is
nowhere close to reining in its debt problems," said Charlene
Chu, the former Fitch Ratings Ltd. analyst known for her warnings
over China’s debt risks and now a partner of Autonomous Research
Asia Ltd. "It is one of the key factors weighing on GDP growth
and one of the reasons why foreign investors are so concerned about
China’s trajectory."
A report Tuesday is
forecast to show China’s 2015 expansion slowed to 6.9 percent --
the weakest pace since 1990. Strength in services and consumption
last year cushioned a slowdown in old growth drivers like heavy
industry and residential construction.
Chinese renewed
share rout has roots in the debt mess: an eye-popping rally late 2014
and early 2015 was fueled in part by official media commentary that
championed the surge as a new way for companies to finance growth and
repay borrowing. But instead of companies deleveraging, the result
was a surge in margin traders taking loans to pile in as the number
of equity investors surpassed the number of communist cadres. When
the inevitable bust came, policy makers responded to cushion the
fall.
The meddling has
proved largely ineffective and often counterproductive: Leaders had
to abandon a newly imposed stock circuit-breaker system introduced on
Jan. 4 after price plunges cut short trading sessions twice last
week. Even as regulators tried to calm sentiment, the People’s Bank
of China surprised traders as it weakened the yuan the most since
August by cutting the currency’s daily reference rate against the
dollar.
Meantime, the
central bank has been spending hundreds of billions to offset massive
capital outflows and support the yuan. Its stockpile of foreign
exchange reserves plunged by $513 billion in 2015 to $3.33 trillion.
With global assets
from commodities, U.S. blue chips and emerging currencies shaken this
year by China’s sliding equities and weakening yuan, policy makers
have been criticized.
"The government
has made a complete hash of the past six months in terms of sending
signals," said Fraser Howie, co-author of the 2011 book “Red
Capitalism: The Fragile Financial Foundation of China’s
Extraordinary Rise."
Examples abound.
When authorities last year lifted a ceiling on bank deposits to allow
freer pricing, they followed up with guidance to banks not to use too
much of their new-found freedom, showing the tension between reform
and control. In Shanghai, a much championed free-trade zone has
largely disappointed.
Policy Blunders
"It makes one
wonder whether Chinese policy makers are students of Goethe -- ‘By
seeking and blundering we learn,’" said Barry Eichengreen, a
University of California-Berkeley professor.
In an effort to
restore confidence among investors and strengthen oversight, China’s
cabinet has created a new department to coordinate financial and
economic affairs, under the General Office of the State Council,
according to a person familiar with the matter. The No. 4 secretary
office is tasked with coordinating between financial and economic
regulators and gathering data from local offices.
Hand of State
How effective that
move will be remains to be seen. Since taking power in late 2012,
President Xi has consolidated power and dominates economic
policymaking, a role traditionally left to the premier. Xi promised
in 2013 to let markets have a decisive role, but analysts have been
disappointed by the pace of change.
The Communist Party
is unlikely to relinquish its control over economic matters any time
soon, said Chen Zhiwu, who sits on the International Advisory Board
of the China Securities Regulatory Commission (CSRC), the nation’s
stock market regulator. "It’s that misunderstanding that goes
to the heart of China’s dilemma," the Yale University academic
said.
"In my
lifetime, an American-style free market will never become a reality
in China," said Chen, who advised the government on establishing
the China Investment Corporation, one of the nation’s sovereign
wealth funds. "China is much more for a very active government
hand. That cultural heritage will not be easy to change."
Debt Pile
There’s also been
no real progress in chipping away at the debt burden, supercharged by
spending on infrastructure and housing, that delivered average
economic growth of 10 percent over the past 30 years. Government,
corporate, and household borrowing totaled $28 trillion as of
mid-2014, or about 282 percent of the country’s GDP at the time,
according to McKinsey & Co.
"Some of the
recent policy moves on the stock and foreign-exchange markets are
indicative of tension between the leadership’s desire for
market-oriented reform and the apparent fundamental objective of
control by the government and, ultimately, the Party," said
Louis Kuijs, head of Asia economics at Oxford Economics Ltd in Hong
Kong. "Indeed, the response of international markets may in part
reflect rising worries about this tension."
The dilemma for the
nation’s leadership is that they have highlighted the need for a
more market-driven allocation of capital, which would stoke
productivity gains and drive growth as the working-age population
shrinks. Yet the turbulence that markets produce threaten to
undermine confidence in the party that’s dominated government since
1949.
Markets Spooked
To be sure, it
doesn’t take much to spook investors on China these days, and
recent market ructions appear disconnected from signs of
stabilization in the underlying economy. Evidence indicates consumers
are still spending, house prices are steadying and export demand is
recovering.
"The
international reaction has probably been bigger than it should have
been, given that China’s equity markets are not very related to the
real economy nor yet very connected to international markets,"
said Tim Summers, senior consulting fellow on Asia at Chatham House.
There’s also been
some progress on the reform front. Most interest rates are now at
least influenced by market forces, and the PBOC scored a big win by
qualifying for reserve currency status for the yuan from the
International Monetary Fund late last year. All this while Xi’s
drive to root out government corruption continues to roll ahead.
Still, given the
ever-present debt overhang and muddled market policies, there’s
been an erosion in confidence as to whether Xi and his policy makers
are in control and have the ability to manage the scale of the tasks
at hand.
"At the most
basic level, we have no idea whether Xi understands what modern
markets require," Arthur Kroeber, the Beijing-based founding
partner and managing director at Gavekal Dragonomics, a research
firm, wrote in a note. "China is unlikely to collapse. But it is
losing its way. And it is this loss of direction, rather than a
moment of confusion on foreign exchange markets, that should really
worry investors."
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