Local debt hurting more than
China's economy By Willy Lam
The apparent failure of the Chinese
Communist Party (CCP) leadership to rein in
reckless borrowing by local administrations has
raised serious questions about the efficacy of the
country's stimulus package - and the viability of
its vaunted economic model.
Last month,
the National Audit Administration (NAA) disclosed
that regional governments had run up debts
totaling 10.72 trillion yuan (US$1.65 trillion).
Independent credit agencies have reckoned that the
actual figure is around 14 trillion yuan, or 35%
of the country's gross domestic product (GDP).
These horrendous debts show the party-state
apparatus may be losing control over the regions'
finances.
More significant is the fact
that 33 years after Deng Xiaoping
kicked off the era of
reform, the country is still dependent on
old-style state investments to boost GDP growth
rates. The recent data points seem to indicate
that efforts by the Hu Jintao-Wen Jiabao team to
focus on consumer spending and technological
innovation as new engines of growth - which is the
leitmotif of the 12th Five-Year Plan of 2011 to
2015 - face formidable challenges ahead.
At a State Council (cabinet) meeting early
this month, Premier Wen said Beijing would pull
out the stops to curtail borrowing by local
governments as well as so-called urban development
investment vehicles that enjoy official backing.
"The size of local government debt being formed
over the past several years is relatively big and
some risks loom, as some regions and industries
are weak in repaying the debt," the official
Xinhua News Agency quoted the State Council
statement after the meeting as saying.
"Local governments must continue to clean
up and standardize the financing vehicles in a
timely manner". Western economists have estimated
that as a result of defaults and delayed
repayments, Chinese banks' non-performing loans
(NPL) ratio may soar beyond 10% in a few years'
time.
A key reason why Beijing has been
unable to whip regional cadres into line is that
the "warlords" are in their own fashion following
Beijing's overall policy of relying on
state-funded projects to foster economic
expansion. Last year, fixed-assets investments
accounted for an estimated 46.5% of GDP. In late
2008, Premier Wen unveiled a package worth 4
trillion yuan - some 50% of which would be
bankrolled by local administrations - to sustain
high-level growth in the face of the global
financial crisis. The bulk of this gargantuan
capital injection has gone into infrastructure
projects as well as real-estate and related
sectors.
Given that the property market
began to heat up soon thereafter, spending on
housing construction and allied activities has
gone into high gear since 2009. Regional officials
are particularly keen on property-related areas
because the sale of land and incomes such as
property-transaction taxes make up at least half
of local revenues. And it was not until last year
- when the bubble had reached outsized proportions
- that the State Council took serious measures to
contain over-building and speculation.
While outlying the 12th Five-Year Plan
earlier this year, Premier Wen said that in the
interest of restructuring the economy, the State
Council was lowering the annual growth rate to
just 7%. This has fallen on deaf ears in the
provinces and major cities, many of which have
loudly proclaimed plans to double their GDP during
the five-year plan period. According to Beijing
University of Science and Technology economist Hu
Xingdou, local cadres are convinced that
faster-than-normal economic growth is a ticket to
a quick promotion up the hierarchy. "They don't
mind incurring tons of debt because it's the
responsibility of their successors, if not the
central government, to return the money," said
Professor Hu.
An even more potent
incentive for officials to go after
property-related businesses is private gains.
Local "warlords" who have been given death or
suspended death sentences this year due to illegal
land- or property-related deals include the mayor
of Shenzhen, Xu Zhongheng, and the vice-mayor of
Hangzhou, Xu Wanyong.
Central-level cadres
have also got into the act, thus rendering
Beijing's efforts to douse overzealous investments
in the localities even more difficult. Last month,
Li Yuan, a former vice-minister of land and
natural resources, was kicked out of the CCP after
he was subjected to investigation for reportedly
taking bribes from developers and related
transgressions. Other senior cadres who have been
jailed for property-related corruption include the
vice-president of the Supreme People's Court,
Huang Songyou.
[More recently, China
Daily.com reported on July 20 that Xu Maiyong and
Jiang Renjie, former vice-mayors of Hangzhou and
Suzhou respectively, were executed on July 19 for
taking bribes and abusing their official powers,
according to the Supreme People's Court. Xu, 52,
had interfered with real estate contracts and
helped companies and persons obtain land,
promotions and tax breaks, the report said.
Between 1995 to 2009, he accepted about
145 million yuan (US$22.2 million) in bribes and
embezzled another 53.6 million yuan from a
state-owned property-development company, and
illegally returned 71.7 million yuan of land
purchase payments - money the government collects
from property sales - to a property development
firm in which he held a stake. Jiang, 63, between
2001 to 2004 helped to ensure certain property
developers had an advantage in obtaining land and
project contracts. In return, he received more
than 108 million yuan in cash, the report said.]
Moreover, given the top priority that
Beijing has given to maintaining stability, the
warlords are telling the central leadership that a
truncation of construction and related projects
could have devastating socio-economic impact. As
Nottingham University Sinologist Lina Song pointed
out, "for poorer areas, a sharp reduction of local
public investment would mean a reduction in
employment and a rise in poverty". So far, the CCP
authorities' only strategy seems to be to play up
the principle that cadres "must pass muster in
both ability and morality, with priority given
[to] morality" to be promoted. "Morality" is a
long-standing code word for abiding by
instructions from the central leadership.
While individual economists estimate that
China's total public debt is as high as 80% of
GDP, it is unlikely that a massive default on
regional loans - triggered for instance by the
bursting of the housing bubble - will plunge the
nation into recession. Most of the loans are
issued by domestic institutions. Moreover, the
government still has a big war chest. Central
revenue was 8.3 trillion yuan last year. Also, the
country holds $3 trillion in foreign-exchange
reserves.
Yet, as Xu Xiaonian, Professor
of Finance at the China-Europe International
Business School (CEIBS) pointed out, "Beijing is
merely burning money to keep the capital projects
going." Comparing China to a patient, Professor Xu
noted that "burning money and printing renminbi
[yuan] can make him look good, but it doesn't mean
that his sickness can be cured".
Equally
significant is that the country's excessive
reliance on state outlays as a vehicle of growth
means that the main goal of the 12th Five-Year
Plan encouraging domestic consumption and
technological innovation - is being jeopardized.
Consumer spending has remained tepid despite a
series of state incentives such as repeatedly
raising the minimal wage for urban workers.
The average savings rate of urban
households relative to their disposable incomes
rose from 18% in 1995 to nearly 29% in the late
2000s. The share of private consumption in GDP has
fallen to about 35%, the lowest figure among large
developed and emerging-market economies. Chinese
people still prefer to save given the inadequacy
of medical insurance and old-age pensions.
Equally important is the fact that in the
past decade, while the income of the government
and state-held corporations has increased
dramatically, workers' remuneration as a
proportion of GDP has dropped by close to one
percentage point annually. Last year, workers'
salaries were equivalent to a mere 25% of GDP,
versus the world average of 55%. This phenomenon
of guofu minqiong ("the state getting
richer while citizens remain poor") will of course
depress consumer spending.
Beijing's
developmental strategy of betting big on state
injections has also hurt the country's
once-vibrant private sector. Much of the
government funds that were used to fight the
global financial crisis have ended up in
state-controlled firms at both the central and
local levels.
Even before the on-going
credit crunch, private firms could get, at most,
one-third of the loans made available by state
banks. Since the spring, even the most resilient
private enterprises - for example, those in
Wenzhou, Zhejiang, long known as China's
quasi-capitalist haven - have felt the pinch.
Wenzhou officials have indicated that local firms
have to pay some 60% interest rate to secure loans
from underground financiers.
CEIBS's Xu
has deplored that as a result of the over-emphasis
on state investments, "the government and
state-owned enterprises have increased their
dominance from steel to real estate. .... Thirty
years of privatization have basically been brought
to a halt," he said.
The retreat of the
private sector has cut into the country's ability
to enhance innovation in technology and
management, which is a key objective of the 12th
Five-Year Plan. While the World Factory seems to
be making headway with technological advancement,
its high-tech advantages are similar to those of
the Soviet Union and Russia: most of the exciting
achievements the past decade have come from
military or state-controlled laboratories and
plants.
State-of-the-art gadgets have
included super-fast computers, high-speed trains
as well as jetfighters and missiles. Global
experience has demonstrated, however, that
imaginative, user-friendly products for the
consumer market usually come from private firms
that are unencumbered by state fiats. The recent
setback suffered by the non-state sector could
bode ill for China's overall innovation drive
through the rest of the decade.
In his
keynote speech marking the CCP's 90th birthday,
President Hu Jintao admitted that "problems of
unbalance, lack of coordination, and
unsustainability in development are outstanding",
and that these structural impediments must be
"resolved through deepening reform". The supremo
cited the magic word "reform" 44 times during his
14,000-character address.
The fact that
Beijing has chosen to procrastinate rather than
tackle urgent issues such as regional
indebtedness, however, does not seem to augur well
for the future of reform. According to
Northwestern University Sinologist Victor Shih,
who has written about irresponsible borrowings by
local administrations since 2009, "The government
had delayed acknowledging the problem for a long
time."
"After three separate internal
audits conducted by the Ministry of Finance, the
China Banking Regulatory Commission and the
People's Bank of China last year, the State
Council realized that the situation was serious,"
he told China Brief. "Now, I still think the top
leadership does not want to acknowledge the full
scale of local debt."
Since a drastic
cut-off of credits to localities would create
voluminous bad debts, Professor Shih said,
"Beijing's solution is to muddle along for a
couple more years." The onus is on the Hu-Wen
administration to show the world that it can come
up with efficient and expeditious ways to grapple
with the economy's myriad bottlenecks.
Dr Willy Wo-Lap Lam is a Senior
Fellow at The Jamestown Foundation. He has worked
in senior editorial positions in international
media including Asiaweek newsmagazine, South China
Morning Post, and the Asia-Pacific Headquarters of
CNN. He is the author of five books on China,
including the recently published Chinese
Politics in the Hu Jintao Era: New Leaders, New
Challenges. Lam is an Adjunct Professor of
China studies at Akita International University,
Japan, and at the Chinese University of Hong
Kong.
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