China ready for more stimulus
World champion for debt – and more probably still to come
by Bronwyn Curtis
Wed 8 Apr 2015
The Shanghai Composite equity index rose to its highest level since March 2008 this week and is up nearly 20% this year. Local retail investors are betting that the government and People's Bank of China are set to provide more stimulus as all the main economic indicators point to further weakness.
The policy package that came out of last year’s annual People’s Congress was, at that time, the boldest for decades. It hasn’t been enough. This year the policy language was markedly stronger and more growth supportive; and actions have swiftly followed. The most recent has been the loosening of mortgage rules for second homes. It won’t be long before interest rates and banks' reserve requirements are cut again.
There has been so much focus on US economic data and when the Federal Reserve will raise rates that China has been relegated to a second-order problem. That is a mistake.
Japan and the euro area have implemented quantitative easing, but stimulating the economy is just as high on the agenda in China.
Growth has slowed from the heady levels of 11.7% on average from 2003-07, but even maintaining the 7% target for this year will be impossible without further monetary and fiscal stimulus. There are declining returns to stimulus packages, whether monetary or fiscal, as the distortions that have been created are now limiting growth.
Since the financial crisis, China has thrown more money at the problem than any other country. According to estimates from the McKinsey Global Institute, China has been responsible for one-third of the growth in debt globally since the crisis. Total debt (including financial sector debt) reached $28.2tn (282% of GDP) in Q2 2014 against $7.4tn (158% of GDP) in 2007. That’s higher than the US (269%) or Germany (258%).
Much of this increase in debt was engineered to head off the effects of the global financial crisis. China bounced back far faster than the US or Germany. This was not without cost. Nearly half of China’s total debt is related one way or another to the real estate sector. Housing construction accounts for 15% of GDP.
Government debt is a more modest 55% of GDP so there is plenty of latitude to support key sectors like real estate if the data continue to be below expectations. The major risks come from the highly indebted state owned enterprises and local governments - which were the recipients of the surge in bank lending in response to the financial crisis - as well as the unregulated shadow banking sector. If these entities come under pressure the government would have to step in.
Of just as much concern is inflation, which is dropping on weak domestic demand. Producer prices have been negative for the last three years. Although consumer prices are positive, they have been falling since 2011 from over 5% to around 1% so far this year. With inflation falling, paying down debt gets more difficult.
Negative producer prices help businesses, but profit margins have still fallen. Eventually wages will fall or labour will be laid off. We are already seeing signs of that in the purchasing managers indices. The employment index in the official data is close to an all time low. That isn’t good news, as the government needs to create around 10m jobs a year. So the economic balancing act will have to continue – and it is getting progressively more difficult.
Bronwyn Curtis is Chief Economic Adviser, OMFIF.
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