International | Jul 13 2011
– Alarmist warnings of a credit bust in China are unfounded
– China's financial system is under no grave threat
– China is not like the West
By Greg Peel
There are 65 million apartments in China standing empty. This is evidence of fiscal stimulus gone wild, subsidised government lending out of control, and one clear example of why China is heading inevitably towards the same credit bust experienced by the Western world in the Global Financial Crisis.
This oft made claim – almost a tabloid headline – supports the view of the so-called “panda bears” who believe China's uncontrolled stimulus, resultant property boom and associated off-balance sheet credit bubble must eventually bring the post-GFC global economic saviour to its knees, a la Japan in 1990, and a la the US in 2008. It would be extremely disturbing a claim, were it actually true.
The issue is that market estimates indicate that over the past decade, China has only built 60 million new apartments. In the extremely unlikely event that not one of those has ever been occupied, that still leaves 5 million supposedly empty apartments unaccounted for. This sort of alarmism, suggests BlackRock, belies the sort of flimsy analysis upon which the panda bears' conclusions float. The panda bears cite the opaque nature of China's banking system, rapidly growing off-balance sheet exposures and an overblown real estate sector as evidence of a Chinese financial system overdue for crisis that will, by default, cripple world growth and cripple financial systems across the globe. BlackRock economists see the logic of the argument but, like many others they largely dismiss it.
As noted in FNArena's recent feature China Is Not The Next Greece, China is not like anywhere else.
When the Rudd government in Australia leapt into action with fiscal stimulus in 2008, fearing an economic meltdown, that stimulus took the form of government handouts. There were two direct cash handouts, the home insulation scheme and the school building scheme. Irrespective of the disasters befalling the latter two, the investments themselves were not intended to provide any direct payback to the government. The government was merely attempting to fund economic flow-on to retailers and tradesmen and into the wider economy – stimulus of the private sector at direct government cost which absorbed the budget surplus and sent the government into deficit, or debt.
China's fiscal stimulus package, on the other hand, was also organised in haste but involved a lot of lending on projects that were ultimately intended to provide a return to the borrowers, being state-owned institutions or local government bodies, in not just a growth and productivity increase sense but also in a financial sense. Beijing was effectively expecting a profit on its investment in many cases.
“The panda bears,” says BlackRock, “overlook the fact that much of the expansion in China's financial balance sheet has been quasi-financial lending and that such lending is backed and guaranteed by a system that is experiencing rapid growth in income and starting from a low level of overall debt”.
Australia, the US, and the bulk of the Western World went into the GFC with negative savings, indeed high levels of household debt, yet China's domestic savings rate was and still is “almost excessively” high at 50% of GDP. And while much of the rise in Chinese bank liabilities in the last 12 months has come from external funding (bond issues to foreigners for example), China also runs a substantial current account surplus (counter to the US and Europe), is largely domestically funded (has very little in the way of direct foreign borrowings) and “lacks many of the vulnerabilities that undid Western credit systems in 2007-08,” notes BlackRock.
That is not to say that in its haste and inexperience, Beijing has its credit system under complete control. Bad debts in China will inevitably rise, as BlackRock and others believe, and in a worse case scenario there could be as much as 7 trillion renminbi of bad debts in the system already. But China's banks are highly profitable and their balance sheets strong, profit growth is subsidised by fixed lending and deposit rates (not floating, market driven rates) and economic growth itself should be strong enough to absorb most losses without any great challenge to the stability of China's financial system.
[Today's release of China's June quarter GDP showed a higher than expected rate of growth of 9.5%.]
Nor is Beijing likely to sit back and allow household deposits, the main source of domestic savings, to be threatened by bad loans. A revolt by 1.2 billion people is not something the government would like to contemplate. BlackRock suggests Beijing will seek to avoid social discontent “with vigour and resources that would make Western bail-outs appear puny by comparison”.
So does this mean we outside China (and especially in Australia) can all sit back safe in the knowledge that China's rapid credit growth will in no way undermine the strong rate of Chinese economic growth the world has come to so heavily rely on? Not quite.
BlackRock is concerned that China's rate of savings growth will slow over the next few years, and that growth in deposits will become much more “pedestrian” compared to the previous decade. As a consequence of slower savings rates, the economists expect a slowdown in trend growth over the next few years, bringing GDP growth rates down to 7-8% from the 8-10% levels of recent times.
While this may be a concern to BlackRock, it also happens to be the stated intention of the Chinese government. China's GDP growth peaked at around 13% before the GFC and at that point Beijing began introducing monetary policy tightening measures (and more direct measures such as shutting down excess factories) in an attempt to reduce the growth rate to a less “bubbly” 8%. Then along came the GFC to rather speed up the process and send GDP growth rather quickly towards 6% – a level considered to imply recession in China given its rapid population growth rate.
Beijing then introduced its massive stimulus package which (so far) saved the world but which also sent GDP growth back into double digits. In January this year, the government once more declared a target rate of 8% and began tightening monetary policy. In order to avoid a hard landing Beijing has taken its usual softly-softly approach, as evidenced by today's GDP result. If everything goes to plan China will continue its industrialisation and urbanisation boom at a sufficiently measured rate which doesn't threaten an inevitable bust, which can only be a good thing for the rest of the world (and particularly Australia).
It won't be any stroll in the park, but a growing chorus of economists is suggesting the panda bears are inciting unnecessary panic.
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