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Is China's Economy Doomed?

The Buzz

There has been much fretting about China's growth over the past five years. One special focus for hand-wringing has been the Chinese financial system and its non-banking component—the shadow banking system—in particular.

Financial growth in China has certainly been rapid since 2007, a classic warning of impending trouble. In the decade before 2007, credit grew only a little faster than GDP, reaching 187 percent of GDP, which is about normal for an emerging economy.

Then China applied a huge stimulus in 2009 in response to the global financial crisis, mainly in the form of easing the constraints on credit expansion. As a result, China sailed through the crisis with double-digit growth. But by 2014 the credit to GDP ratio had risen to 282 percent, a bit more than Australia or the US and much more than is normal in emerging economies. The shadow banking component led the expansion, growing at 37 percent annually since 2007.

This issue received special attention in the recent McKinsey Global Institute report on global debt. The Fung Institute in Hong Kong has also recently produced a couple of excellent papers on the topic.

The shadow banking sector is harder to delineate than the core banking system because its precise size is confused by fuzzy definitions, double counting of some institutions and under-reporting of others. Based on Chinese central bank data, the Fung Institute puts shadow banking assets a little over 50 percent of GDP, or less than one-third the size of bank credit. McKinsey estimates that the sector is a bit larger.

This is much smaller than the American shadow banking sector, and the Chinese institutions are much less complex.

In China, as in most countries, the expansion of shadow banking is the result of controls and distortions on the core banking sector which prevent banks from meeting the needs of savers and borrowers. They take their unsatisfied financing requirements to the informal financial sector, which expands to meet these needs. Depositors left the banking system because government controls made the interest return unattractive for savers. Borrowers went to the shadow banking systems because banks would not give them loans, or offered only unattractive short-term funding.

With this in mind, the rapid expansion of the shadow banking system should be seen as a phase in the ongoing development of China's finances. There are benefits as well as dangers.

The answer is not to shut it down, but to develop the benefits and minimise the dangers. In the pre-2007 world, much of China's enormous savings ended up funding the expansion of state-owned enterprises, with this investment (or over-investment) becoming less and less efficient over time. Private sector enterprise (the dynamic element in the economy) was starved of funds, receiving only 20 percent of bank credit.

The growth of the shadow banking sector is the transitional means for correcting this—imperfect, but a step towards a better financial system.

An efficient financial system provides finance across the full range of risks, offering safety for risk-averse depositors while also offering high-risk funding for the most dynamic entrepreneurs. The shadow banking sector's proclivity for excess and mindlessly low credit standards (also demonstrated in America and Europe in the period leading up to the 2008 crisis) needs to be reined in while at the same time retaining the dynamism and flexibility. Finding the right balance for the less-regulated non-bank institutions is a challenge for financial policy-makers everywhere, not just China.

So is this a worry?

China's central government has the resources and administrative capacity to prevent a serious macro-economic financial crisis. The central government starts with modest debt levels—27 percent of GDP. Even if it had to absorb the losses envisaged in McKinsey's most extreme disaster scenario, this would take official debt up to around 75 percent of GDP—less than in most advanced economies. Many borrowers also have substantial deposits to offset against their liabilities. While there are substantial credit risks in the housing industry (property developers and builders), most homeowners have little or no debt.

China's huge foreign reserves are not available in any substantive way for domestic financial problems. But these reserves (and the current-account surplus) ensure that China cannot be affected by the flight of foreign money that made the 1997-98 Asian crisis so disastrous.

All that said, it is quite possible, even likely, that there will be numerous bankruptcies (a property crash would be serious, as McKinsey estimates that housing-related credit accounts for 40-45 percent of lending). The central government would have to bail out some local governments (it has already begun taking over small amounts of their debt). As well, the links between shadow banking and the mainstream banks would precipitate balance sheet strains for the banking system.

Financial history tells us that countries that undergo financial deregulation always experience a crisis, to a greater or lesser degree. In China, the deregulation is taking place in a carefully staged fashion. But policy-makers can make mistakes. Markets can lose confidence and growth can be knocked off trend. China's low official debt, substantial government ownership of banks and enterprises, and enormous foreign reserves don't give it immunity from financial troubles, but they do mean that when things go wrong, they can be fixed with less disruption and quicker bounce-back. A Chinese 'Lehman moment' still seems unlikely.

Stephen Grenville is a Visiting Fellow at the Lowy Institute for International Policy and works as a consultant on financial sector issues in East Asia. This article originally appeared on the Lowy Interpreter, here.

Image: Flickr/Stuck in Customs

TopicsEconomics RegionsAsia

Pakistan’s New Missile Disrupts Nuclear Stability in South Asia

The Buzz

Pakistan recently test-fired a surface-to-surface ballistic missile, Shaheen III. Capable of carrying a nuclear warhead, the missile is estimated to have a maximum range of 2750 km. While it has been claimed to provide a boost to Pakistan’s strategic depth and to deterrence stability in South Asia, a careful examination of how Shaheen III impacts the deterrence equation between India and Pakistan captures the latest Pakistani missile to be instead counter-productive.

Shaheen III is the latest addition in the Shaheen series. The previously developed and successfully tested missile, Shaheen II, is estimated to have a range of around 2500 km. The range of Shaheen II continues to remain a rough estimate. For instance, right after Pakistan tested Shaheen II in March 2004, Pakistan’s National Engineering and Science Commission (NESCOM) chairman, Samar Mubarakmand, was quoted saying that “the full range of the missile was 2,500 km although it was tested only to 2,000 km, the edge of Pakistan’s sea limits.” Another ISPR press statement issued on April 18, 2008, after the second successful test of the Shaheen II missile, however, confirmed the missile to have a range of 2000 km. But leading Pakistani newspapers claim Shaheen II to have a range of 1500 km. Based on an estimated range of 2000 km, a map has been made by C SIS that depicts the area (marked with blue dotted lines) that Pakistan could target using Shaheen II ballistic missile. This is critical to note as we question what new capabilities Shaheen III brings to the table.

Right after the launch of Shaheen III, Shahid Latif, retired commander of Pakistan’s air force was quoted as saying that “India doesn’t have its safe havens anymore.” With the ability to reach India’s extreme eastern frontiers, Director General of the Strategic Plans Division, Lieutenant General Zubair Mahmood Hayat, called Shaheen III “a major step towards strengthening Pakistan’s deterrence capability” vis-à-vis India. However, despite all the claims made by strategic experts and military leaders in Pakistan, there remains question on whether Shaheen III enhances the deterrence stability or is rather counter-productive.

From India’s perspective, Shaheen III does not really change the situation much as far as the credibility of Pakistan’s deterrent is concerned. Looking purely from a strategic point of view, Pakistan has had the ability to target all of India’s major population centers with Shaheen II, whose maximum range (2500 km) is estimated to be shorter than that of Shaheen III by only 250 km. Even if we go by the estimated range of Shaheen II at 2000 km which has been successfully tested by Pakistan and confirmed by ISPR, the missile would only miss the extreme eastern tips of India. Thus, when it comes down to “deterrence capability,” Shaheen II can deliver a nuclear warhead to almost all of the strategic sites of India to make the preexisting deterrent credible.

Shaheen III could offer Pakistan the ability to target Indian naval vessels in the Bay of Bengal, but for that Pakistan would need a highly effective and accurate terminal guidance system which could help a missile trace the targeted vessel’s movement and adjust its trajectory accordingly after flying across the entire Indian mainland. Another asset which would make Shaheen III stand out could be the multiple independently targetable re-entry vehicle (MIRV) capabilities, but Pakistan could use these payloads on Shaheen II as well, if it is able to develop or acquire them.

The purpose that Shaheen III could serve best, however, is to give Pakistan the ability to target Andaman and Nicobar islands in the Bay of Bengal. This, as has been argued by General Khalid Kidwai, former head of the Strategic Plans Division (SPD) and advisor to Pakistan’s National Command Authority in a conversation at the 2015 Carnegie International Nuclear Policy Conference, is the “sole purpose for the development of Shaheen III.” However, in the same conversation, he also added that by covering the islands of Andaman and Nicobar, Pakistan aims to take away India’s second-strike capability. But that goes far off from making Shaheen III a strategic deterrent, which Pakistan claims it to be. Instead of strengthening the concept of mutually-assured destruction (MAD), which Gen. Kidwai argues to be critical for South Asia, attempts to take away India’s second-strike capability will further destabilize the deterrence equation. It will push India to further cooperate with its global partners on its Ballistic Missile Defence Programme which will definitely be counter-productive for Pakistan.

Thus, while much has been stated and claimed about Shaheen III from the Indian perspective, it really does not bring anything new to the tableas far as deterrence stability is concerned. On the other hand, if Pakistan aims to take-away India’s second-strike capability, as Gen. Kidwai argues the purpose to be, it will only push India to further enhance its BMD systems. Indian doctrine of credible minimum deterrence is solely based on having a nuclear force that is capable of surviving a nuclear first-strike and launching a second strike which can inflict massive damage to the opponent to make the deterrent credible. Retention of second-strike capability is therefore a vital for stability in South Asia and development of Shaheen III by Pakistan with the aim of taking away India’s second-strike capability will only prove to be counter-productive for the former.

Arka Biswas is a SAV Visiting Fellow at the Stimson Center. This article originally appeared on South Asian Voices, here.

TopicsSecurity

Russia Ditches Plans for Super Advanced 5th Generation Fighter Jets

The Buzz

The Russian military is scaling back initial requirements for the fifth generation T-50 (PAK FA) fighters to twelve planes, after initially planning for fifty-two. Deputy Defense Minister Yuri Borisov said that this was due to economic considerations.

However, Borisov noted that the Defense Ministry reserves the right to determine the number of fifth generation fighters for purchase, so the initial plans may be corrected.

“It would be better for us to have a reserve of PAK-FA and the possibility to move ahead in the future to using the 4+ fighters’ [Su-30 and Su-35] capabilities to the maximum,” Borisov said. In other words, Russia would make the most of its existing Sukhoi Su-35 capabilities, which are highly rated by experts. The United States is currently the only country with an Air Force that includes a fully operational fifth generation jet fighter, the F-22.

Production of the T-50 series will go ahead in 2016 regardless of any reduction in orders. During a visit to the plant where the planes were being constructed, in Komsomolsk-on-Amur in the Russian Far East, Borisov said, “according to the next year plans, we should have the first delivery of the series fifth-generation fighters.”

The T-50 will be a stealth aircraft, invisible to radars. It has several advantages over the F-22: “the T-50 is significantly faster than the F-22, and has a huge advantage in terms of range—5,500 kilometers compared to the F-22’s 3,400. The T-50’s detection systems allow it to spot incoming threats at a distance of up to 400 kilometers, compared to the F-22’s 210 kilometers.” However, Russia’s fifth generation air fleet will be at a numerical disadvantage, as the U.S. Air Force inventory of F-22s is 187.

India is also interested in the T-50, a fact that may help boost purchases. However, India wants to localize production of its T-50s “much like another Russian-designed fighter, the Sukhoi Su-30MKI, which has been in series production for more than a decade at the Hindustan Aeronautics Ltd (HAL) plant in Nasik.”

India is frustrated at delays in its negotiations with the French company Dassault over the contract for the Rafale fighter aircraft.

Image: Wikimedia/Alex Beltyukov

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Japan's Navy Unveils 'Aircraft Carrier in Disguise'

The Buzz

Japan’s largest warship since World War II has just entered service. Japan’s Maritime Self Defense Force (JMSDF) took delivery on Wednesday of the Izumo, a helicopter carrier “as big as the Imperial Navy aircraft carriers that battled the United States in the Pacific.”

The Izumo was indigenously constructed at a shipyard in Yokohama, near Tokyo, at a cost of around $1.5 billion. It is named after the former Izumo province in western Honshu. In Japanese mythology, the entrance to yomi (hell) is located in Izumo.

Perhaps this is apt, as the ship’s capacities definitely have the ability to dispatch Japan’s foes. The Izumo displaces 19,500 tons and is 248 meters (814 feet) long. According to Japanese Defense Minister Gen Nakatani, the ship will improve the Japanese Self-Defense Forces’ capacity to deal with submarines: “As well as having the capacity to search for submarines itself, it will be able to deal with submarines over a larger area as it’s equipped with a lot of helicopters.”

The ship can carry nine helicopters, in addition to 470 personnel. However, in theory, the ship can carry over twenty aircraft. According to reports, while the Izumo “does not have a catapult necessary to launch fixed-wing fighters, a planned vertical-take-off-and-landing (VTOL) variant of the F-35 could fly from the Izumo's flight deck.” This basically makes the Izumo—which gives Japan its largest naval flat surface since the Second World War—an “aircraft carrier in disguise.”

Designating it a helicopter destroyer allows Japan to circumvent its constitutional ban on waging offensive war, as aircraft carriers are considered offensive weapons due to their ability to project force. Japan is also adding “longer-range patrol aircraft and military cargo planes to its defense capability, and buying Lockheed Martin F-35 fighter jets, amphibious assault vehicles and Boeing's Osprey troop carrier, which can operate from the Izumo.”

Natakani noted that the Izumo could project Japanese personnel and equipment in a variety of functions beyond Japan, including “peace keeping operations, international disaster relief, and aid.”  This is all part of a concerted Japanese effort under Prime Minister Shinzo Abe of stepping up Japanese defense spending in the face of an assertive China. Tensions between the two countries are especially great due to a territorial dispute in the East China Sea. In May 2013, Japan said it detected submarines navigating under water close to territorial waters near Okinawa and Kagoshima prefectures.

Nakatani noted that “China has aircraft carriers,” before adding that Japan wasn’t thinking of operating the Izumo as an aircraft carrier. A second ship of the same size and specifications as the Izumo will likely be introduced in early 2018.

Image: Wikimedia/Dragoner JP 

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