China’s government has set its gross domestic product (GDP) growth target this year at 7.5%, but various signals, such as a declining property market and concerns over an overheating economy, indicate that the world’s second largest economy is in some trouble and heading for a possible hard landing. But there are other positive perspectives too. And if 7.5% growth is seen to be a modest, sustainable figure, compared with the double-digit growth of the previous years, how will and how can Beijing avoid a serious downturn and meet its targets for the future?
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The big question in the middle of 2014 is not whether the Chinese economy is in the midst of a downturn, as officials, bankers and analysts acknowledge that a clear slowdown is taking place; the issue is how serious the slowdown will be and what reform measures Beijing will take to keep the economy on track.
The end of the party
For some analysts, China has come to the end of a long period of rapid growth and now must pay the cost of past over-ambitious expansion. One foreign analyst notes: “China used more cement in the past two years than the US used in the whole of the 20th century.” Such usage is unlikely be maintained and has clear consequences.
Non-performing loans (NPLs) of Chinese commercial banks hit Rmb646.1bn ($103.4bn) at the end of the first quarter of 2014. This, according to the country’s regulator, the China Banking Regulatory Commission (CBRC), is a rise of Rmb54.1bn from the start of the year and increases the banks’ NPL ratio by 0.04 basis points to 1.04%, the highest level since September 2008.
Is this the start of worse to come and how will these NPLs impact on China’s economy? The level of Chinese NPLs has been a contentious issue in recent years, with the official figure remaining stubbornly below 1% when market indicators suggest it could be much higher. Western commentators point to huge local government borrowings of about $3000bn, of which a significant amount could be non-performing.
Others cast doubt on Chinese figures generally, and it is important to understand fully how the numbers in such a large and complex economy, such as China’s, really work. Matthew Crabbe, an experienced China observer, in his recent book Myth-Busting China’s Numbers – Understanding and Using China’s Statistics made the following useful observation: “GDP is prescribed and produced by the party-state. That there may be contradictions in the data is, as premier Li Keqiang intimated, of little significance to the party-state. It is more concerned with managing the economy through the institutional levers at its disposal to sustain growth in a direction that maintains social harmony, reduces social conflict, increases social wealth and ultimately legitimises Communist Party rule over China. It may wish to extract itself from such micro-controls, but that could invite even more corruption.”
The numbers game
Understanding what the numbers really mean is hugely important and many Western analysts often view the Chinese economy, and its banks, through a Western economic prism without taking the local political circumstances into consideration.
Also, it is worth noting that China’s ‘big four’ largest banks (Industrial and Commercial Bank of China, China Construction Bank, Bank of China and Agricultural Bank of China), are also all in The Banker’s top 10 World Banks listing and they are all state-owned, a factor that needs to be considered. While these banks are becoming more market-oriented, they are not subject to the same market forces as most banks in the West.
In analysing numbers, the NPL ratio of about 1% is a case in point. While doubts about the accuracy of such figures are a concern, it is interesting to note that Li Wei, a banking analyst at China Galaxy Securities, said in the China Daily in mid-May: “The continued slowdown of the economy will make the rise in bad loans unavoidable.” He emphasises, however, that the current financial risks are still controllable. He adds in a somewhat sympathetic reference to Beijing’s approach: “It takes time for China’s industrial restructuring to make a positive impact on its economic growth. In about two years, when the economic reform takes effect, the banks will have better control of their NPLs.”
How slow is the slowdown?
So how should the current slowdown be interpreted? Alarmists in the West say China may be facing meltdown and they may be right, but seasoned observers in Beijing think otherwise. Dr Yu Yongding, senior fellow at the Chinese Academy of Social Sciences, a leading think tank, says: “Anything can happen, but there is not a very high probability of meltdown, especially if China does not make mistakes.”
He notes that since 2012 China’s working age population has been in decline by 2 million people per year, and pressure on job creation has been reduced, the modest GDP growth target of 7.5% is not that difficult to achieve. He adds that China needed to lower growth for environmental protection reasons, mirroring official views that too rapid growth had damaged the environment and was not sustainable.
Other analysts point to the impact of significant reforms stemming from last November’s Communist Party plenum, where an extensive plan is creating a bigger role for market forces as well as for private and foreign companies. This is on top of a strong emphasis on combating corruption and improving corporate governance and the rule of law. Analysts agree that these reforms, as radical as they appear, will take time to implement but add that the new government is sticking hard to its task in the typical way of a command economy with a five-year plan, unlike many Western economies seeking instant gratification before the next election.
In addressing the type of crisis China could face, Mr Yu outlines where some of the problems lie as well as the buffers Beijing has to offset these issues. He notes that China has invested too much in real estate development (13% to 15% of GDP or higher) and has built too much, pointing to China’s 690 five-star hotels and the 500 under construction, the 400 skyscrapers and the 370 under construction, and the massive production of cement, estimated at two-thirds of the world’s total.
But while Mr Yu believes total real estate lending may amount to 20% of total loans or even higher, he is confident that even if house prices fall by more than 20%, the nature of the damage done to the Chinese economy would be far less than the property crises in Japan in the 1990s, where real estate lending was estimated at 50% of all lending, and in the recent $12,000bn subprime mortgage crisis. He adds that, unlike the West, China has some protection through a high savings rate of more than 60%, and a less sophisticated and less leveraged financial sector, plus it has more than $4000bn in foreign exchange reserves as additional protection. He concludes: “You should not write off China too soon. You cannot guarantee China will not fail but it does have considerable buffers to protect the financial system.”
Lurking in the shadows
Another key financial concern is shadow banking, which bankers and officials see both positively, in parts, and also negatively. Much depends on definitions and Chinese shadow banking is seen as very different from that in the US and Europe and is concentrated around trust funds.
Clear figures on the size of China’s shadow banking industry are hard to come by, and careful monitoring and regulation are only just developing. In a paper on Shadow Banking in China at the Massachusetts-based Political Economy Research Institute (Peri) in August 2013, Jianjun Li and Sara Hsu concluded: “The shadow banking system, excluding informal finance, is small relative to the rest of China’s financial system according to the size of total assets, but its credit scale (net financing) is larger than that of commercial bank loans. Looking at the scale of financing, the size of the shadow banking system has exceeded that of the commercial banking system. That means the shadow banking system is impacting the monetary policy transfer mechanism and regulatory performance.”
Industrial and Commercial Bank of China’s chairman, Jiang Jianqing believes not all shadow banking is bad and it can play a role in the country’s economy, but he adds much more regulatory attention must be paid to the sector. The Peri paper agrees, saying: “China’s financial economy is innovative and fast-paced, and monitoring will require connection to the shadow financial sector.”
China’s economy is moving into a new phase of lower sustainable growth and there are likely to be some serious bumps along the way. But while falls in property prices and rising local debt are worrying, the new government seems well aware of the possible problems and has a range of tools at its disposal to see off any dangerous meltdown on the horizon.
