The basis for Premier Wen’s assessment, widely endorsed by Chinese and international economists, is that China must move away from exports and fixed-asset investment (in short, building things) as the dominant drivers of economic growth. From the mid-1990s to early this century, net exports accounted for about half of China’s growth each year. From around 2003 onward, fixed-asset investment drove around 40 percent of GDP growth. In 2009, due to the massive fiscal and monetary stimulus ordered by the government in response to the global slowdown affecting China’s key export markets of America and the euro zone countries, 80–90 percent of growth was the result of capital investment. This is reflected in the increase in formal bank lending used for fixed investment. Such lending jumped from $150 billion in 2001 to $380 billion in 2003, then to $750 billion in 2008 and $1.4 trillion in 2009. (The figures in 2010 and 2011 dropped slightly to around $1.2 trillion.) On the back of increasing bank loans and other bank credit that now amount to around 250 percent of GDP, fixed investment is currently responsible for around 50–55 percent of GDP growth.
Indeed, fixed investment as a share of GDP jumped from a relatively sustainable 35 percent in the 1980s to 45 percent in 2004. Many analysts now believe that fixed investment amounts to more than 60 percent of GDP. Still a poor country, this means that China is pouring far too large a percentage of national savings into building things that are not utilized or wanted by the population, and its households are consuming too little. Even during periods of rapid industrialization in Japan, South Korea and Taiwan during the 1950s, 1960s and 1970s, fixed investment as a proportion of GDP stayed below 30 percent, except for one or two years when it approached 35 percent. To be sure, the movement of rural citizens into cities and surrounding suburbs is always associated with a rise in fixed investment, and China is no different. However, with an urbanization rate of only around 1–1.5 percent each year, we are witnessing the most rapid (and undoubtedly unsustainable) buildup of capital investment in any economy in recorded history.
Economically, the country’s reliance on fixed-asset investment is enormously wasteful. The vast majority of fixed-investment activity is undertaken by centrally and locally managed state-owned enterprises (SOEs), even though domestic private firms are generally two to three times more successful on measures such as return on investment, profitability and economic efficiency. These SOEs dominate all major sectors of the Chinese economy (except for export manufacturing), including commodities, utilities, chemicals, heavy industry, infrastructure, construction, shipping, banking, finance, insurance, media, education, renewables, IT and advanced IT platforms. They also receive around three-quarters of all formal bank loans issued by the state-owned and state-dominated banking sector throughout the country.
This massive SOE bias would make more economic sense if the approximately 120 centrally managed and 150,000 locally managed entities were deserving of such support. Some well-known Chinese state-owned giants such as Sinopec, China Mobile and the China National Petroleum Corporation make enormous profits each year, albeit in virtual monopoly environments within which they enjoy privileged access to capital. Yet, even among better-run centrally managed SOEs, around 80 percent of all profits are generated by fewer than a dozen companies.
The performance of the locally managed SOEs is even more abysmal. According to consolidated estimates of various case studies, 19 percent of SOEs were unprofitable in 1979, 40 percent were unprofitable in 1997 and 51 percent sustained losses in 2006. It is reported that risk-management procedures in this lending have been highly questionable, and an estimated 30 percent of bank loans are extended for “policy” reasons rather than sound commercial considerations. Thus, fears of a growing problem of nonperforming loans (NPLs) would appear to be well grounded.
Indeed, this cycle has been replayed before. Between 1998 and 2005, the government injected more than $250 billion worth of cash to bail out its banks. During the same period, around $330 billion worth of these NPLs were transferred off the books of Chinese banks into specially created “asset-management companies,” with the banks receiving the full worth of the NPLs in return. To date, the average recovery rate of NPLs by asset-management companies is about 25 cents on the dollar.
Since 2005, bank loans have more than doubled with little change in lending policy. Indeed, state-owned banks were ordered to roll over an estimated $1.7 trillion worth of maturing loans to local SOEs at the end of 2011, with most of the capital having been used for the construction of speculative high-end residential property by these local government-owned “financial vehicles.”
Estimates by major rating agencies, international accounting firms and other researchers of the true size of NPLs in the Chinese financial system vary from 40 to 150 percent of GDP. Although no one knows the true extent of the NPL problem in the Chinese banking system, there is widespread recognition by Chinese authorities and economists that a growth model driven by building things that are neither required nor used is not a sustainable path for the country. Indeed, the widespread Chinese and international focus on transitioning from a fixed-investment (and to a lesser extent, export-led) model toward growth based on domestic consumption is an explicit admission that the viability of the economic approach since the early 1990s is coming to an end.
