/

Next time, China might have to face the fire

by Yu Yongding

Earlier this year, rumors of China’s impending financial doom — triggered by either a housing-market crash or local-government debt defaults — were rampant. But, in recent months, the economy has stabilized, leaving few doubts about China’s ability to grow by more than 7 percent this year.

Given that the Chinese government had ample scope for policy intervention, this turnaround should come as no surprise. But the moment of financial reckoning has merely been postponed, not averted. The fundamental problems that triggered alarm bells in the first place — including real-estate bubbles, local-government debt, rapid growth in shadow-banking activity, and rising corporate leverage ratios — remain.

Of these, the most immediate threat to China’s economic and financial stability is the combination of high borrowing costs, low profitability for nonfinancial corporations, and very high corporate leverage ratios.

According to a study by the Chinese Academy of Social Sciences, the debt/GDP ratio for China’s nonfinancial corporations was 113 percent by the end of 2012. Standard & Poor’s found that, a year later, these firms’ total debt amounted to $14.2 trillion, eclipsing the $13.1 trillion of outstanding debt in the United States and making China the world’s largest issuer of corporate debt.

There is no indication that the ratio will decline anytime soon, which is particularly worrisome, given the low profitability and high borrowing costs that China’s industrial enterprises face. Indeed, Chinese firms’ profitability amounted to just over 6 percent last year, with 2012 profits for China’s 500 largest (mostly state-owned) corporations barely exceeding 2 percent.

Meanwhile, interest rates on bank loans to nonfinancial enterprises remain close to 7 percent, despite having fallen slightly over the last year.

And, in the second quarter of this year, the annualized interest rate on loans to small nonfinancial corporations surpassed 25 percent.

With insufficient profits to use for investment, nonfinancial corporations will become increasingly dependent on external finance.

As their leverage ratios increase, so will their risk premiums, causing their borrowing costs to rise and undermining their profitability further. This destructive cycle will be difficult to break. For example, if companies reduce investment, they will weaken growth and boost their leverage ratio further.

To be sure, China overcame a similar challenge in its public sector from 1998 to 2001. It pursued growth-boosting investment in infrastructure and real-estate development to eliminate deflation, while maintaining artificially low interest rates to contain the rise of public debt. But a lot has changed since then.

In fact, the investment-led growth model that facilitated double-digit growth in the decade after 2001 has exacerbated structural weaknesses, which must now be addressed.

Indeed, China must stem the pace of real-estate investment, which accounted for more than 13 percent of GDP in recent years — a move that will undoubtedly lead to slower economic growth and, in turn, reduce the profitability of China’s nonfinancial corporates further.

Moreover, ongoing interest-rate liberalization — which has occurred both openly and surreptitiously — means that artificially low borrowing costs have become far more difficult to maintain.

Although the People’s Bank of China still officially caps interest rates on deposits, commercial banks — in cooperation with nonbank financial institutions, especially trust companies — are using wealth-management products to attract deposits with de facto free-market interest rates. As a result, the PBOC is losing control over interest rates on corporate loans, and thus has few options for constraining leverage ratios.

Despite these risks, it is too early to bet on a corporate-debt crisis in China. For starters, no one knows at what corporate leverage ratio a crisis will be triggered. In 1996, when Japan’s public debt/GDP ratio reached 80 percent, many Japanese economists and officials worried about a looming crisis.

Almost two decades later, the ratio has surpassed 200 percent — and still no crisis has erupted.

Furthermore, China has not yet completed its market-orientated reforms, which could unleash major growth potential in many areas.

Given the role that institutional factors play in China’s corporate-debt problem, such reforms could go a long way toward resolving it.

China’s leaders should take advantage of this respite from instability and low confidence to redouble their reform efforts. Otherwise, they can expect alarm bells to begin ringing again — and, next time, they may not have the tools they need to silence them.

Yu Yongding, former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006. © 2014 Project Syndicate (www.project-syndicate.org)

  • velocitybox

    I am a Chinese working as a China analyst at a think tank. It is becoming more and more apparent to many people, that the ruling Chinese Communist Party (CCP) knows it is on its last straw of survival.

    The party is facing severe and increasing systematic stress on all fronts:

    1. Increasing external oppositions from all other countries in the world including all of China’s neighbors. They are forming more and more alliances and becoming more outspoken with rising strengths against China, in addition to increasing anti-China sentiment from people in all other countries. Many countries including Canada and Australia have tightened their immigration policy to prevent Chinese from entering their countries. Even on these casual internet message boards, when you look past the paid Chinese propaganda professional commenters, you notice rising general anti-China feelings from all over the world.

    2. Increasing internal severe and massive violent social unrest and anti-CCP mutiny from people of all Chinese living places e.g. mainland China, Hong Kong, Taiwan, Xinjiang, Tibet, Macau etc. To beat down internal dissent, the CCP every year is forced to spend even more money than on its massive military budget. This is continuously worsened by the free flow of information, with Chinese people knowing more and more from travelling abroad and learning about truths from jumping beyond the “Great Fire Wall” on the internet.

    3. Its own economy and social condition never able to develop to higher level beyond mass skill-less manufacturing, due to complete absence of law and common morals. High technology and innovations and scientific development all require many citizens working together voluntarily contributing long term in a system they trust, with things like rule of law, no censorship on knowledge, no restrictions on speech and expression, copyrights, patents, common morals when collaborating and trading with each other etc. These qualities are all destroyed in modern China by the CCP. When was the last time you heard an announcement of technology development or innovations or scientific breakthrough coming from a Chinese organization / company / university? You haven’t because there ain’t any. The only way modern China gets these things is from stealing and spying from all other countries, but that has become much more difficult since the whole world has caught on to their act.

    This systematic fatal weakness is why you do not see even one Chinese brand or company that can compete in the international market in any industry of the human race. No rule of law in China also means no people or businesses, both Chinese and foreign, ever invest in China long-term or on a large scale because everything frequently change on a whim along with the political climate. No one trusts any contract or agreement in China because they are always broken by the Chinese and there is no legal protection whatsoever, meaning China can never advance to a knowledge economy or service economy. No rule of law also ensures Shanghai fail to become a financial city despite the CCP dumping huge resources into it for 30 years.

    4. China’s mass skill-less manufacturing itself is going away to other countries due to increasing costs and openly hostile and unfair business environment full of frauds and sanctioned protectionism and government robberies. The labor force is endlessly more demanding both in wages and benefits expectations and working conditions, especially since all of today’s Chinese workers are single child used to coddling and indulgement by their families. It is further worsened by the rise of robotic automatic manufacturing and 3D printing. This situation is a death knock to the “growth-based legitimacy” of the CCP, which is the only thing CCP can rely on for continuing ruling power. For sure Chinese people tolerate the CCP when the economy seemingly explodes, but when one day it crashes and the country’s hopeless bad shape hit them in the face the people’s “support” for the CCP will turn on a dime.

    Since six months ago, all the major economic indicators for China have gone on a continuing nosedive – including manufacturing orders, export volume, commercial investments, corporate credits, foreign capital inflow, domestic consumptions, real estate prices, Chinese tourist numbers and spendings, luxury goods demand, HSBC Service PMI, survey of business sentiments etc. The CCP is on its last resort of printing literally trillions of worthless renminbi to dump into the economy, causing way more long-term harm than short-term help, and when that is over there is nothing else the CCP can do to prop up the failing economy. China currently ranks 82nd on GDP per capita and that is the highest it can go before falling sharply in the coming near future.

    5. Fierce unstoppable purges and mutually-destructive infighting among different factions within the party, who are imprisoning and killing each other every day. This power grab goes on under the laughable thin guise of “anti-corruption drive” when everyone knows all officials in china are corrupted. No work to manage the country or guide the ship is being done while this is going on.

    6. Its many previously-suppressed fatal problems have all grown too big to be contained all breaking out at the same time e.g.

    - severe carcinogenic poisonous pollution everywhere in air and water and soil and their own food etc, with the WHO issuing multiple warnings on Chinese population having the fastest cancer growth rate in the whole world
    - skyrocketing unrepayable bad debts of all kinds everywhere, its true scope unknown because all data from China are faked
    - biggest housing bubble in human history, in addition to innumerous crumbling “ghost cities” and shoddily-built vanity project infrastructure that cannot and will not be used
    - rapidly aging demographics with a 140:100 male:female gender ratio (from one child policy, culture of “leftover women”, and many Chinese families killing their own daughters so as to chase boys)
    - world’s no.1 wealth inequality, with a Gini coefficient rivaling 18th century France just before the French revolution
    - complete absence of soft power / cultural influence / social attraction, one result of which is minimal and sharply dwindling number of foreign professionals and tourists and students going to China
    - all Chinese chasing foreign-brand goods and services while ditching low-quality Chinese-brands, who have a well known history of poisoning their own food and their own baby formula so as to make more money. This dashs CCP’s hope to build indigenous industries and a domestic consumption economy
    - corruptions and fraud throughout the whole rotten core of a system
    - desperate mass exodus at all levels of Chinese society to escape the country using emigration or buying houses / study abroad or marriage to foreigners or plain old human smuggling, resulting in all able Chinese leaving taking huge amounts of talents and money out of the country
    - the law of large numbers and the “middle-income trap” all work against the “growth-based legitimacy” CCP desperately needs for its survival

    Most importantly, the CCP knows that if 1.4 billion Chinese learn about basic human qualities such as morals, truth, fairness, human rights, rule of law, freedom, universal values etc the CCP will be toppled very quickly. Therefore its state-controlled brainwashing education and propaganda machinations ensure a complete lack of morals and regard for laws in all Chinese growing up and beyond. This results in failure in all basic aspects of human interactions with every modern Chinese, whether it is business trading / personal dealings / technology development / creating innovations / human communications / scientific research / artistic expressions / teamwork collaborations / academic exchange etc. Another propaganda brainwashing technique used by the CCP is to make all Chinese people pathologically nationalistic and very emotional on this issue, so the CCP can always create and point to some “foreign enemies” so as to hide all the domestic crises and government robberies going on. This attention-diverting technique is the same trick magicians have used for more than a thousand years to fool their audience.

    An interesting example would be the Chinese reaction to this report – they are expected to dismiss this report as total rubbish, accuse the author “unpatriotic” for saying the truth, shout China will only become richer and stronger than all other countries, yet they will give no counter-arguments and they will make no acknowledgement to the horrible factual conditions and complete lack of basic human qualities listed above in modern China. Ironically, the longer Chinese people deny or refuse to acknowledge the CCP problem, the longer they are only digging themselves into the hole and hurting themselves for any chance of recovery. Consider the example of Google, Facebook, Wikipedia, Youtube, Twitter, Instagram etc – these services are all completely blocked in China while at the same time the rest of the planet are on these services every second communicating ideas with each other, making friends, exchanging knowledge, doing business, working together, improving science and technology and arts, and advancing humanity.

    Some people say China economically developed a lot in past 30 years, but the truth is this “development” is actually debt borrowed against the future. After the 1989 Tiananmen Square massacre of their own students, in order to survive and hang on to power, the CCP was forced to pursue short-term explosive economic growth that sacrifice everything else, including a foundation for future economic and social development. This “scorched earth” policy is like winning the lottery for corrupted CCP officials who can rob a lot of money from the country in the short-term before escaping to America. The only entity left to suffer is China’s future starting from now, a country that has been turned by the CCP into a place with no law, no morals, no system for future scientific or economic or social development, no spiritual support apart from money, no trust or cooperation among Chinese, no trust or goodwill from foreigners, no other country as friends, all resources sold away cheaply, entire environment and air and water and soil and food fatally polluted, only social recognition is to make a lot of money for “face”, no creativity or personal development for Chinese young people, a populus not allowed to know the truths and not allowed to say the truths.

    The end result is that majority wealth of this “debt borrowed against the future” has gone to the 0.0000001% elite ruling class “princeling” CCP families (about 250 of them) who have already smuggled trillions of dollars abroad along with their U.S. passports and their own children (all Chinese elites and Politburo members hold foreign passports, with U.S. and U.K. being the most sought after choice). For the CCP in 1989, 1.4 billion people is great central-planning asset when the country start from nothing and you order them to do backbreaking mass manufacturing repetitive work 20 hours a day without workers protection of any kind. But in the 2014 borderless knowledge economy when that no longer works, 1.4 billion immoral and uncooperative and selfish and undeveloped and angry Chinese contained in a lawless system without any hopes of growth is very, very dangerous liability for the CCP.

    All debts against the future have to be paid back – China is no exception. That moment may arrive a bit later than expected but it surely will come, as it has on 100% of occasions in human history. For China the moment has arrived to suffer the consequences for all its own chosen actions in past 30 years. All the festering fundamental systematic problems listed above and much more, are only getting worse and worse everyday until one day when the system can suddenly no longer bear.

    Think USSR in 1989.