China must choose: growth or lasting economic health. It can’t have both
It is an irony of the so-called free economies that their governments are more constrained than China’s when it comes to pursuing growth. China’s central bank can print as much money as the economy needs; its government can order state-owned banks to make available as much credit as it wants.
Neither situation is possible in a market economy, where the central bank is independent and banks, most of which are privately owned, make decisions purely on commercial grounds.
Herein lies the key to China’s phenomenal growth of recent decades. Whenever the economy loses momentum, the government uses its “visible hand” to give growth a boost.
This explains why China’s aggregate money and credit supplies hit a record high last month. The economy is grappling with a host of unprecedented internal and external challenges, not least among them ballooning debt and off-balance-sheet borrowing by local governments.
China’s total social financing (TSF), a broad measure of credit and liquidity in the economy, surged to 4.64 trillion yuan (US$690.2 billion) in January from 1.59 trillion yuan in December. While this increase, much stronger than markets had expected, might be driven partially by seasonal factors, the trajectory of the credit cycle is decided by the pace of monetary and fiscal policy expansion. The January TSF is the highest since the central bank began publishing such data in January 2002.
This credit boom has been led largely by rising loans, undiscounted bankers’ bills, and a pickup in the issuance of local government and corporate bonds, thanks to financial policy easing.
In recent months, Beijing has started policy easing to counter economic headwinds, using a mix of monetary and fiscal measures, amid a steady slowdown of growth over the past decade. Last year’s 6.6 per cent GDP growth was the lowest since 1990.
Meanwhile, China’s M2 money supply – a broad measure covering cash in circulation and all deposits – soared to a record high of 186.59 trillion yuan (US$27.8 trillion) this January, from a record low of 5.84 trillion yuan in January 1996. To put that in perspective, the US’ January M2 was US$14.467 trillion, or half of China’s.
That suggests that months of government efforts to spur lending to support China’s cooling economy are having an effect, even if debt levels are now at an unacceptable level of near 300 per cent of GDP. In fact, China’s debt to GDP ratio stayed flat in 2017 and moderated in 2018, under a deleveraging campaign to reduce risk. The government wanted stimulus measures to help the cash-strapped private sector, but state banks traditionally put politics above economics, preferring to lend to state-owned enterprises and big projects with political support.
But make no mistake: a rebound in credit growth and a slowdown in nominal GDP growth would mean the debt to GDP ratio would rise again.
As growth will almost certainly slow in the first quarter of this year, the government is expected to roll out more policy support when Premier Li Keqiang delivers his State-of-the-Union-style policy speech at China’s annual legislative session in early March. The government has already set out “six stabilities” – employment, foreign trade, foreign investment, domestic investment, financial markets and market expectations – as its policy priorities this year.
It has also chosen some pro-market measures to boost growth, such as tax cuts and deregulation, which will not create more debt. The government should focus on the restructuring of its state-dominated banking system, the last remnant of Stalinist economics, to help promote the efficiency of the capital market – again, a measure that will not create new debt.
Reform measures to deleverage the excessive credit in the economy, a clamp down on shadow banking, efforts to control off-balance-sheet borrowing by local governments and supply-side manoeuvres to eliminate excess capacity production have all had some effect on short-term growth.
But the crux of the matter is that the government can’t achieve two opposing goals – deleveraging and boosting growth – at the same time.
So policymakers face a difficult choice: either loosen credit to boost growth, or accept slower growth as a necessary step to market reform and long-term economic health.
Source: South China Morning Post