China abandons its pursuit of growth at all costs; Beijing knows the stakes are too high to allow for anything other than a gradual change of dosage

China abandons its pursuit of growth at all costs

January 22, 2014 4:54 pm
By David Pilling
Beijing knows the stakes are too high to allow for anything other than a gradual change of dosage
If Hu Jintao was a growth junkie, Xi Jinping wants to put China’s economy on a methadone programme. Under Mr Hu, the former president, Beijing was addicted to economic expansion. China defied the collapse in external demand that followed the 2008 Lehman Brothers crisis by ramping up spending on roads, ports and smelters through a huge expansion of credit funnelled into the economy via compliant banks and local governments desperate to meet centralised growth targets. The economy grew at near double digits even as exports slowed dramatically and the current account surplus shrank from 10 per cent of output to just 2-3 per cent.
As with heroin, though, the ecstatic highs had side-effects. The economy became ever more dependent on quick fixes. It took more and more inputs – in the form of easy credit and cheap raw materials – to produce each unit of gross domestic product. Debt, some of it unrepayable, rose sharply. Capacity ballooned beyond demand.
Mr Xi, who took over the presidency in March last year, has served notice that enough is enough. From now on, China will not pursue expansion at all costs. The quality of growth will be emphasised. There have been several indications of a change of heart. Short-term interest rates have been allowed to rise almost 3 percentage points and credit growth has been slowed from a hair-raising peak of 23 per cent to a (still hardly abstemious) 18 per cent. The cost of material inputs, from electricity to water and land, will be subject to market forces.
Local governments are – at least according to official propaganda – from now on to be judged not by the speed of growth but by the progress they make in other areas, including cleaning up bad debts. When it comes to borrowing, the government has come clean, up to a point. Two audits have been published detailing the rise in public debt. Even the more sanguine one admits to a near 70 per cent rise in local government obligations in just two and a half years, or 40 per cent if contingent liabilities are excluded.
Implicit in this change of direction is a trade-off between growth and economic efficiency. The government is expecting growth of about 7.5 per cent in 2014. In previous years it has made its forecast deliberately low and then come in triumphantly above expectations. This year, if anything, it could go the other way. By the end of 2014 growth may be slowing towards 6 per cent, even if the result for the year as a whole is still likely to be 7 per cent or above.
A shift from the inefficient state sector entails risks but anyone who stands in the way could end up on the wrong side of the ‘law’
Very high growth is not as important as it once was. China’sworking-age population
has begun to shrink. Although many university graduates find it hard to get the jobs to which they aspire, unemployment for the economy as a whole is not likely to be a problem. If higher-quality growth is now the aim, the means is to allow the private sector a bigger role. The hope is that if the banking sector is liberalised and private companies are allowed to compete against inefficient state-owned enterprises, capital will be allocated to better-run corners of the Chinese economy.
Arthur Kroeber of GaveKal Dragonomics reckons that if every renminbi funnelled to the state sector were transferred to private enterprise, productivity could be as much as doubled. By that “magic trick” growth could be maintained even as levels of investment – still running at 6-7 percentage points above GDP – were cut. In practice, the transition is unlikely to be so smooth. This implies that, if the government does not revert to the norm of the Hu years by opening the credit spigots when the going gets tough, growth will slow faster than some are currently bargaining for.
Beijing will take things steadily so as not to provoke a crisis. In late December it gave local governments permission to roll over debt. Many have borrowed short-term in order to finance long-term projects, some of which will not turn a profit for years, if ever. Local authorities have been told to lengthen their debt maturities. That suggests they are being chivvied to put their finances on a sounder footing. Much attention has been paid to local government debt, much of it off balance sheet. But corporate borrowing may turn out to be a bigger problem. According to the Chinese Academy of Social Sciences, if state-owned enterprise borrowing is included, total government obligations rise to 151 per cent of GDP. In one of the first visible signs of stress, loans to a near-bankrupt coal company that were bundled up and sold to retail investors as a wealth management product are on the verge of default. ICBC, the world’s biggest bank by assets, which distributed the investment vehicle, has so far refused to stand behind the $500m issue.
A shift from the inefficient state sector – which actually expanded during the Hu years – to the private sector entails risks. It is also bound to tread on some powerful toes. Opposition, though, is likely to be muted given Mr Xi’s crackdown on corruption. Anyone who stands in the way could end up on the wrong side of the “law”. Some onlookers, in their perennial hunt for crisis, are waiting for the Chinese economy to blow up. The outcome, however, may be more benign: slower growth of somewhat better quality.