Perilous summer for China's blazing
economy By David Fullbrook
Summer has arrived in China, bringing
soaring temperatures, drenching humidity, and -
for at least the third consecutive year - growing
fears that the economy is hurtling out of control
and threatening to crash, in spite of government
efforts to turn down the heat.
Trade was
out of balance, in the black to the tune of a
record US$13 billion, last month (a fifth more
than in April) on the back of factories producing
goods worth 706 billion yuan ($88.2 billion), 17%
more than in May 2005. Banks lent 1.78 trillion
yuan from January to May - scarfing up a
shockingly high proportion of the year's quota of
2.5 trillion yuan set by the People's Bank of
China (PBoC), the central bank, and 793 billion
yuan more than was lent
in
the first five months of 2005. Not surprisingly,
urban investment was up 30.3% over the same
period. Growth for the second quarter seems
unlikely to be much less than the 10.3% chalked up
between January and March, and may even be more.
During May the amount of money sloshing
around the economy, according to the M2 yardstick,
grew by 19.5% from a year ago to 209.4 billion
yuan, the fastest rate since January. Wages
continue to rise along the coast, with factory
hands in Guangdong province now
pocketing on average 50% more than they did in
2004 for the same hours. That, along with sharp
rises in energy and commodity prices reflecting
strong worldwide demand, has some people fearing
that inflation will take off even though consumer
spending remains subdued. Only last autumn, the
talk was of deflation.
Causing all this
worry is money - quite simply, more money than
China's economy can handle, as the nation becomes
a victim of its own success. Much of the money
comes from exports, which the world loves because
with $1 buying about 8 yuan they are ridiculously
cheap, causing China's economy to overperform.
Exchange controls and tight restrictions on
Chinese banks, funds, firms and citizens'
investments in foreign stocks, bonds and property
keeps money trapped in the economy, save for that
spent on imports. No wonder the vaults of the
People's Bank are brimming with reserves of about
$900 billion.
Investors and speculators
are also carrying money into China, quite
literally in suitcases in some cases. Now that the
yuan has begun what looks like being a long-term
rise against the dollar, investors and speculators
alike are keen to get their money in before the
yuan becomes any stronger, which in turn promises
more profits later when they take their money out
of China. Of course, legitimate investments are
also plentiful, as overseas firms pay for
factories and Chinese staff.
Quite a lot,
however, is simply looking to take advantage of
soaring property prices, a consequence of people
wanting nicer homes and a lack of alternative
investments. In Hangzhou, a lakeside town near Shanghai once favored by
emperors but today the haunt of nouveaux
riches, people are shelling out about 9,000
yuan per square meter for residential property, a
steep rise from only 2,000 yuan a decade ago. Yet
the average monthly wage packet in the city holds
only 2,000 yuan.
With foreign assets out
of bounds, the local stock markets a long way from
being fixed, and futures markets only just getting
going, property and black-market lending are the
only ways to earn a greater return than the paltry
interest paid by the banks, which, as ever, are
awash with savings because bills for schooling,
pensions and health care are rapidly growing even
as the communist-era safety nets fray. Thrift
makes people feel safer. According to the Fujitsu
Research Institute, the propensity to consume has
fallen 10 points over the past decade.
And
of course plenty of such illegal lending ends up
buying bricks and mortar. Consequently, many urban
Chinese think property a sure bet. Shanghai taxi
drivers believe the city government will not let
property prices fall before millions arrive in
2010 to visit the International Exposition,
planned as much as a showcase for Shanghai itself
as for products and technology.
The boom,
or bubble, fed by such torrents of money is
impressive to say the least, and not a little
giddying. For now, however, it is still not as hot
as during the early 1990s when not only was
investment even greater, but prices were climbing
by about a fifth each year, while now they
struggle to mark time despite rising labor and
material costs. Yet one can read too much into
that comparison. China's economy today is a quite
different beast. Not only is it more than twice as
large, it has, with the massive growth of private
enterprises, taken on a direction of its own,
straining at the government leash.
However, even as the character of the
Chinese economy has changed immensely, the
government's sticks for controlling it remain
rather crude. In recent days, Beijing ordered
banks from July 5 to increase their reserves
against outstanding loans from 7.5% to 8%, an
increase withdrawing roughly 150 billion yuan from
the banks' pool of lendable funds. JPMorgan in a
subsequent report reckoned the step was mild,
reflecting concerns about big selloffs on stock
markets worldwide and a little patience to see
whether the 0.27% increase in the benchmark
one-year lending rate to 5.85% in April, the first
since 2004, and other tightening measures this
year would rein in investment and take the edge
off the economy.
That the measure was
announced on a Friday evening, rather than the
usual Thursday, suggests central bankers were up
late with their calculators, spreadsheets and
models working out their response to the surprise
data.
Even though, compared with how much
money Chinese banks have lent out this year, 150
billion yuan is a bag of watermelon seeds, the
reserve-ratio increase was nevertheless a warning
to lenders to stop pouring money into mortgages
and firms in hothouse industries such as autos,
cement and steel. Those that do not take heed will
be forced to buy government bonds paying paltry
interest rates.
Given that, for most of
this decade, Beijing has been trying to cool the
economy and bring the banks to heel with such
administrative measures, there seems little
prospect they will work this time around.
Nevertheless, administrative measures remain
popular because the government can aim them at
particular sectors or cities, avoiding hitting
weaker parts of the economy with the same hammer
as stronger parts.
But fine-tuning such
policies is difficult indeed. Data are inaccurate,
so bad in fact that the PBoC has devised complex
formulas to counter the lies and fantasies mixed
in by provincial officials and cadres eager to
deliver the right numbers. Given that the market
economy is only half-built and developing rapidly,
government economists lack not only sufficient
experience, but also the decades of historical
data that can help craft better remedies for the
economy's ills.
Inadequate data make it
difficult to know just how hard to tug on the
leash. Tugging too hard could bring the economy
abruptly to heel, causing a slump. But if the
economy failed to obey, the leash would be clearly
broken, severely damaging the government's
credibility while the economy ran out of control
on its way to an inevitable crash. Neither outcome
bears thinking about during the run-up to 2008,
when the world's spotlight turns to Beijing for the Summer
Olympics.
Further, Beijing's control over
provincial and local officials, judges, police and
party cadres is weakening as the economy grows,
except when it comes to silencing loudmouthed
dissidents crying foul over official corruption,
environmental damage, and even political change.
That makes executing policy slow at best. Often,
orders are simply not heeded. National and local
interests are increasingly diverging.
Even
in Beijing, traditional hutong houses,
officially protected, are being demolished daily
barely a stone's throw from Zhongnanhai, the home
of China's leaders. Orders to close death-trap
coal mines, something of a cause celebre
for President Hu Jintao and Prime Minister Wen
Jiabao when they took over in 2004, are regularly
ignored. Thousands that should be shut down remain
open. The reasons are not complicated: China needs
coal, people need jobs, and officials and mine
owners want profits.
Banks, as shown by
their eagerness to continue lending this year, do
not pay much attention to government orders when
it suits them. Branch managers are keen to lend,
often in cahoots with local officials, property
developers and cadres. Shanghai, for example, has
seen its economy grow at an almost 13% annualized
rate between January and April, suggesting it will
far exceed this year's goal of 10%.
Moreover, because new loans rarely turn
sour immediately, they increase a bank's apparent
financial performance by boosting its fraction of
"performing" loans as a percentage of all loans.
And despite sterling efforts and huge cash
injections by Beijing, for China's banks bad loans
remain a huge problem - $800 billion according to
an estimate by Standard & Poor's, a
credit-rating agency. Furthermore, even when the
banks do follow orders, lending continues thanks
to the huge and growing illegal lending market,
complete with underground banks.
Clearly
administrative measures are turning blunter. So
what else is left? Well, issuing more bonds could
mop up some of the excess cash sloshing around,
but by no means all of it. In any case, this cash
helps to lubricate a relatively inefficient
economy. Draining off cash and raising reserves
could also choke off lending to well-run private
firms, which already find it hard to get bank
loans and could not access the cheaper financing
available from the stock markets, even if they
worked (which they don't, not very well, anyway).
So such firms will be compelled to either put off
expansion - which creates badly needed jobs - or
borrow at usurious rates from the black market.
Boosting interest rates could help, but
probably not much. Higher rates increase the
pressure on banks, economically marginal
state-owned factories, and home buyers. Savings
might even increase, when what the government
really wants is people to spend more, creating
more local demand, thereby reducing the dependency
on exports for jobs and social stability. More
overseas money might also be attracted by better
returns, compounding the cash surplus and placing
more pressure on the tightly controlled currency
rate.
That rate, which keeps the yuan
weaker than it otherwise would be, is, as JPMorgan
points out, the crux of the problem because it
keeps export revenues high. A stronger yuan will
make Chinese exports more expensive abroad,
causing demand to fall, while making imports,
especially commodities and energy, cheaper, easing
the bills now crimping manufacturers, efficient
and incompetent alike.
Yet the yuan will
need to appreciate substantially - far more than
the 3.5% rise seen since last July - really to
make a dent in exports. That is because only about
a quarter to a third of a shop price tag is
accounted for by the factory gate price in yuan;
the rest is the retailer's margin, shipping costs,
middleman charges, and taxes, mostly priced in US
dollars. Even then, export demand might not ease
substantially because the dollar is weakening
against euros, pounds and yen, so shop prices in
Europe, Japan and the United Kingdom are unlikely
to rise sharply.
A rising yuan worries
many officials, though. They fear that a slowdown
in exports will cost jobs if Chinese do not spend
more to take up the slack. There is little chance
of that happening, with most of the population
wondering how they will pay their bills and
support themselves in old age. The shopping
districts of Beijing, Shanghai or even backwater
Kunming, capital of Yunnan province in
southwestern China, are often thronged with
people, but relatively few tote shopping bags:
most are simply window-shopping.
Cutting
the yuan loose is also distasteful to cadres and
officials on the left. They remain a powerful
force, and may well be taking heart from the
aggressive neo-nationalist trend recently seen in
Russia, Venezuela, Bolivia and elsewhere.
Right-leaning cadres (or "reformers" in the
Chinese political context) want to push on with
liberalization, believing that more, not less, is
needed to keep the economy on track.
Overlapping with this conflict is the
tussle between the Shanghai clique, personified by
former president Jiang Zemin, and the Youth
clique, springing from the Youth League and inland
provinces led by President Hu and Premier Wen.
Though the Youth clique holds the top posts, the
Shanghai group continues to hold many key posts in
the Politburo, China's cabinet, and bureaucracy
until their terms expire in 2007. It is
anticipated that most of the vacancies will be
filled by the Youth clique, finally consolidating
Hu's power.
Consequently, bold policy
moves are not so likely before next year's
Communist Party conference. In the meantime
central bankers will be left to wield their
increasingly blunt administrative tools and give
little tugs on the leash, hoping the banks behave
for a bit.
In the absence of any sharp
shocks from overseas, such as a recession in the
US or oil prices zooming past $100 a barrel,
China's economy will probably carry on pell-mell
as it has done for a few decades now, accompanied
by the usual swings in sentiment between
crash-landing and overheating.
But should
a serious shock strike the economy, it seems
increasingly likely the government will fumble and
flail, unable to keep a half-built market economy
standing with one hand while the other continues
to dismantle the command economy. Stagnation and
social strife should not come as a surprise.
Investors may not stick around if the going gets
rough, instead salvaging what they can and making
for Bangalore, Delhi and Mumbai.
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