A mini stimulus, if justified, should go toward boosting China’s future competitiveness, not toward reviving construction or local government finance. The urgent task is to prepare for a new growth cycle based on a jump in competitiveness. Backward-looking spending merely worsens the debt situation and postpones the necessary economic restructuring.
Three areas require special attention: globalizing the white-collar labor force, upgrading manufacturing and planning the 21st century’s megacities. The country’s main goal for the next five years should be preparing for the future, not targeting some GDP numbers.
Reviving construction and local government finances are the worst ways to spend money. In the name of stimulating the economy, more money is being wasted. The country has a shortage of blue-collar labor. What’s the point of stimulating construction and related factory activity?
Internet businesses, mainly in sales, are increasingly viewed as the economic future. This is a fad. Replacing people going to the shop with deliverymen will not create a more competitive economy. China must make better products to enhance competitiveness.
Too Much Debt
Too much debt permeates the country’s economy, local governments and businesses. As I travel across the country, I mostly hear about local governments and businesses that are absorbed with managing solvency by resorting to ever fancier borrowing tricks. Many, if not most, local governments are borrowing to pay the interest on their debts. Businesses often cook up new projects to borrow more so they can manage their existing debt stock.
Debt and overcapacity form a vicious spiral. The latter diminishes cash flow for debt-laden projects. As local governments and businesses borrow more in the name of new projects to pay interest on existing debt, they exacerbate the overcapacity situation. China must stop the debt-capacity spiral. Continuing it provides no way out.
The redevelopment of slums seems to be a part of mini stimulus. It works through loans for the said purpose. Local governments that are supposed to do the job are not in a position to take on more debt. In one province, I observed that a loan is being stuffed through a state-owned enterprise that will relend to local governments in the province. That enterprise is being forced into doing this because it has some capacity to take on more debt while local governments do not. The process is essentially creating bad loans for that enterprise, while higher-up people will not be held responsible.
An overwhelming majority of cities have an oversupply of property. If some slum areas require development, the priority should be given to using up the existing surplus stock. It is wrong to stimulate construction, in the name of developing slums, just to print a better GDP number for one quarter or two. What will one achieve in the end?
Stimulus Isn’t Necessary
The shortage of manual labor is widespread. Even though the mining industry is in a deep slump, it is difficult to find a miner for 10,000 yuan per month. Past or new stimulus only creates more debt to expand construction or factory activities. Both need more blue-collar labor.
The rationale for stimulus during an economic downturn is to decrease unemployment. Idle workers are a waste of resources. Stimulus, even if it wastes money, works if the waste is less than the earnings for the reemployed workers. This reasoning does not work in China now. Increasing demand for blue-collar workers merely intensifies wage inflation. The real purpose of recent stimulus is for a cosmetic reason, i.e., a better looking GDP number.
But a better looking GDP number is not better. The economy is in trouble because of a 2008 policy that spent money just for higher GDP numbers, while disregarding quality and sustainability. If the economy gets more of the same, how can one expect a different outcome?
The country does have surplus of white-collar workers. College graduates accept wages that are far from reflecting their educational costs. Parents have essentially forgone consumption to subsidize the supply of white-collar workers. If the government wants to help, it should facilitate economic restructuring toward household consumption on the demand side and service on the supply side. Only a different economic model, not more of the same, can help college graduates.
Banks Shouldn’t Cover up NPLs
The next economic cycle begins with a detailed plan for disposing non-performing loans (NPLs). It appears that the financial system is far from that. Indeed, the knee-jerk reaction is to deny the existence of a large NPL problem.
I hear anecdotal evidence that some banks are stretching out NPLs and lending a bit more to keep the underlying projects operational. Sometimes, banks look for new owners with loan inducements. Lower interest rates and longer tenures on existing loans and new loans are some of the usual inducements. The loans in the mining and commodity trading sectors are in trouble now.
As the property market falls, more and more land-backed loans will become delinquent. Most of the country’s loans are related to property. Local governments borrow with land as collateral. Developers, households and local governments account for about half of the total loans. Property prices will likely decline by half from the peak in 2011. The price of land will fall by 70 percent from its peak. The NPL ratio in property-related loans will likely be large.
Stretching out loans and suspending property sales at a loss are the usual tactics for covering up bad loans. Japan did that for a decade. After a property bubble bursts, the economic recovery can only gain strength when the financial system cleanses itself of the bad loans and is recapitalized.
The talk of stimulus merely delays the necessary financial restructuring. It gives banks and other financial institutions the incentive to cover up NPLs out of hope that stimulus can create another rising tide to wash away all the bad loans.
The stimulus talk may be part of the psychological warfare to achieve a soft landing. It may confuse speculators from running for the exit together. The trouble is that it may confuse financial institutions too. They must come clean and start to deal with NPLs, otherwise, the economy cannot achieve a vigorous recovery.
*Read the entire article at Caixin.