Time Bomb: China's Debt Is Out of Control
“Once you start thinking about growth, it's hard to think about anything else,” remarked the economist Robert Lucas, who won the Nobel Prize for his work on the topic. Policymakers in China agree.
Since 1979, GDP growth has symbolized the nation's dynamism, determination and confidence, and China's growth machine has spawned an industry of forecasters who jostle over decimal points.
In recent years, the totemic 8 percent has been gradually guided down to 7-7.5 percent as “the new normal.” National GDP hit 7.4 percent last year, controversially missing the 7.5 percent official expectation. Policymakers are attuned to market reactions, so feel obligated to deliver “7-point-something.” Growth at all costs has become a dangerous obsession, without heed to prudent economic management. There is a law in economics stating that variables become meaningless once targeted; Chinese GDP might well qualify.
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Of course China's GDP isn't meaningless. It's huge, it's real, and it's merely slowing “from a very big base.” It represents a stunning 40 percent of total world growth and it seems churlish to question it. Still, there's always been something a little fishy about this dataset. It gets reported far sooner (in 19 days) than in any other major economy. In punctual Tibet they report even before quarter's end!
More advanced economies regularly revise growth data retroactively; China's GDP is suspiciously accurate and seldom corrected. And it seems no longer to correlate well with other underlying indicators, suggesting officials or statisticians may be smoothing the data.
Shanghai's recent removal of its target is likely to be followed by other provinces currently in thrall to “GDP-ism.” The economy's high and rising dependence on investment has been criticized as unsustainable. “7.X” growth, like the magic formula for Coca-Cola, is seen as contrived. There are a few cynics who mutter that the Chinese growth number is a fiction, too good and too stable to be true.
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There is another explanation: Beijing really is delivering the reported number but is straining to do so.
China's national balance sheet is starting to look ragged. Goldman Sachs thinks China's industrial debt is, at 240 percent of GDP, approaching American levels, but at a much lower development stage. McKinsey reckons China has piled on 83 percent debt/GDP in 2007-14. In this period, total debt has quadrupled, certainly the world's largest ever credit buildup but also one of the fastest. This latter point is significant. By Goldman's count, China is coming off a “97th-percentile” episode of credit accumulation. Historically about half of such events have culminated in a banking bust. Since China “doesn't do crises,” it must eventually correct through rebalancing.
China has much going in its favor.
It has excess savings, which are captive. Although foreign borrowing has soared, external liabilities are less than 10 percent of GDP. There is large “catch-up” potential remaining. Goldman calculates cumulative capital return rate is 15 percent, double America's, meaning there is still much room to deploy investment. But as Greg Clark has noted, that doesn't mean it will be done efficiently in the future: “a manager of the Eastern Bengal State Railway, touring the United States in 1901, remarked that most American railways were not up to European or Indian standards.” Clark's point is that long-term growth is derived from the efficient use of railways (to take a germane example), not how “advanced” the locomotives are.
Much of China's capital is trapped in dud state companies that are all too capable of pursuing white-elephant projects. Many of these companies are local government entities, and stories of alarmingly leveraged municipalities (here and here) are surfacing. Undeterred, 14 provinces (of China's 31) have already unveiled US$2.5 trillion of new projects for this year “to bolster economic growth.”
For now, total debt continues to outpace nominal GDP growth by 6-7 percent annually, meaning that debt/GDP keeps piling up. There is an insouciant view, expressed once to me by a Japanese central banker when discussing quadrillions of yen of public borrowing, that debt is “just a bunch of zeroes.” It doesn't matter, since it's “owed to ourselves.” But Japan's experience actually informs otherwise. And Goldman's historical database suggests that a growth hiccup of at least 2-4 percentage points would normally ensue. The days of 7-point-something growth may be over soon.
Julian Snelder is a Kiwi who has resided in Asia for almost a quarter-century. This piece originally appeared on the Lowy Interpreter.
Image: Flickr/Premshree Pillai