Feature Stories | Mar 22 2016
This article was first published for subscribers on March 17 and is now opened to general readership.
By Greg Peel
The Chinese Growth Myth
“It is normal for a fast-growing economy to slow at some point,” suggest Commonwealth Bank’s international economists. “China is no exception”.
It is no wonder smaller investors are sent into panic mode every time there is less than positive news out of China. It is the preserve of the popular press to come up with the most shocking headline it can. Good news is all a bit dull. The fact the popular press mostly has absolutely no idea what it is talking about is by the by.
For the past decade, China’s rate of economic growth has been slowing. The days of double-digit GDP results are now long gone and if one were to take the popular press headlines at face value when growth dropped to 6.9% in 2015, you’d think the world was coming to an end. “Lowest growth in 25 years!” The hyperbole is similar every time China’s manufacturing PMI shows another month of contraction. Never mind that Beijing’s structural reform agenda includes a reduction in over-excessive manufacturing.
Indeed, I would wager very few in the popular press could, if pushed, correctly define a purchasing managers’ index.
But we’re not here simply for a bit of media bashing, as much fun as that might be. The point here is that yes, there are certainly reasons to be concerned over the trajectory of the Chinese economy. One must, however, understand what one is actually concerned about.
China’s GDP has grown from just US$200bn in 1978 when economic reforms first began, CBA notes, to US$10.4trn in 2015. China’s GDP per capita has increased over that period by 129 times. China is still considered an “emerging market” because despite having grown to be the world’s second largest individual economy, it is still a long way from being “developed”. The rate of China’s growth has been slowing this past decade, but then, so it should.
Nothing can grow at a double-digit pace for ever. The bigger an economy becomes, the smaller the incremental percentage of GDP growth each year’s dollar value of GDP represents. China’s 6.9% growth in 2015 added US$600bn to GDP. To generate that same dollar value in 2016 would require a growth rate of only 6.5%, CBA notes. Last year Beijing set a growth target of 7.0% and achieved 6.9%. This year the target is 6.5-7.0%.
Looking at it around the other way, to notch up US$600bn in 2010 China’s GDP would have had to have grown by 10.4%, and in 2005, by 17.8%. China’s average growth rate of 10.5% achieved over the past decade is equivalent to only 5.8% required for the period 2016-20.
CBA believes China will become a 5-6% growth economy in 2020. One can just imagine the headlines: “CBA predicts major Chinese growth collapse!” But indeed, the opposite is true.
From the mid-noughties, assumptions of the pending rise of China as a global economic powerhouse, more colossal than that of post-war Japan given its population, were based on the “urbanisation and industrialisation” thematic. Twenty years ago the vast bulk of China’s populace were subsistence farmers. Over that period many of those farmers have moved to the cities, attracted by the growth of Chinese industry. China has built more cities as a result. Beijing’s official target is to increase China’s urbanisation rate to 60% by 2020.
The standard urbanisation rate of a major developed economy is 80%. China is, thus, still emerging. CBA believes ongoing urbanisation remains the key pillar for the future growth of China. Given the rate reached 56% in 2015, that target of 60% by 2020 should not be difficult to reach, albeit there remains an urbanisation rate imbalance between coastal regions and the vast inland.
Every one percentage point of urbanisation growth brings another 17m Chinese to live in cities, boosting consumption, service and investment growth. An average urban Chinese consumes three times that of rural counterparts, CBA notes. There follows a flow-on to investment, as more people require more housing, roads, airports, schools and hospitals.
While CBA acknowledges such growth does not follow a straight line – there will be macroeconomic cycles and external shocks along the way – so far China is enjoying higher incomes despite the country’s various economic issues. Around 20m Chinese move from poor rural areas to prosperous urban areas each year, thus becoming more productive, being paid more, and consuming more.
“Such a powerful trend,” says CBA, “should allow China to continue to grow at a decent speed for many years to come”.
Not that there aren’t issues overhanging. Since the GFC, China’s debt to GDP ratio has increased dramatically. Investment efficiency (dollars in to dollars out as GDP) has fallen to its lowest level since the 1978 start of the reform process. There is much concern over hidden asset impairment in the Chinese financial sector (non-performing loans). Here, ongoing reform is the only solution, CBA suggests.
Beijing has indicated its determination in restructuring the country into a more sustainable consumption and services-based economy. The government will soon release its thirteenth five-year plan, providing detail on its reform agenda through to 2020.
For those who lay awake at night worried about Chinese growth, it must be remembered that reform and restructure can be an initially painful business. Just ask the retailers of luxury cars or proprietors of Macau casinos, for examples, just what impact Beijing’ crackdown on corruption amongst government officials has had on profits. Or consider what impact Beijing’s attack on China’s shadow banking system had on global financial markets. Steps forward in economic growth require initial steps back.
And of course there is concern from outside China that when it comes to reform implementation, Beijing is very inexperienced. Witness the comical, day by day flip flopping of stock market rules witnessed during last year’s Chinese stock market collapse. Or the People’s Bank of China’s ill-thought out sudden devaluation of the renminbi.
We can only hope that with each bungled experience, and a loss of face in the eyes of the rest of the world, the Chinese government will learn.
The Debt Issue
CBA cites as a major concern China’s debt to GDP ratio, which has grown to 243% at the end of 2015. That 243% is, nevertheless, but one measure. China’s financial markets are a long way from being fully reformed and any outside estimate of Chinese debt always comes with a caveat of “as far as we can determine”.
National Australia Bank’s economists have had a go at assessing a more accurate measure of China’s debt, including that outside the country’s traditional banking system which has grown considerably since the GFC. China’s “shadow banking” industry is notoriously opaque.
CBA cites a figure provided by the Bank for International Settlements. NAB has attempted to broaden that measure, by including bank loans, shadow banking, government bonds and non-shadow banking aggregate financing. This measure renders a figure of 308% of GDP as at the end of 2015. Even that should be considered conservative, warns NAB, given it does not include wealth management products and the more recent development of a peer-to-peer lending market, for which there is no data.
Debt, NAB reminds us, is not necessarily a bad thing. The value of debt can be assessed by comparing a country’s nominal credit growth to nominal GDP growth. A ratio of one to one suggests debt is being used effectively to promote economic growth, as was the case for China between 2004 (when the expression “super-cycle” was coined) and 2008 (the GFC).
But since 2011, China’s economic growth has seen a sustained slowdown, yet credit growth has accelerated. Shadow banking has provided the increase, NAB notes. Using NAB’s wider measure of debt, as opposed to the widely accepted BIS measure, debt was growing at around three and a half times the rate of economic growth at end-2015.
Allowing such a rate of debt growth to go unchecked would increase the likelihood of a major financial crisis, NAB notes, and a perennially feared “hard landing”. But China’s five-year plan target growth rate of 6.5% per annum is unlikely to be achieved without growth in debt. To put the brake on debt growth would mean missing the target GDP growth rate, which is unlikely to sit well with Beijing.
One of Beijing’s reform agendas is nevertheless to tackle overcapacity in industry and so-called “zombie” companies. Companies suffering overcapacity and low profits thus face a higher chance of default. Unlike the US, for example, China has not entered a deleveraging process post-GFC, and thus the risks are increasing.
Global credit insurance group Coface notes China’s outstanding private sector debt (non-bank) reached 201% of GDP in mid-2015, up from 176% in mid-2013 and 114% in mid-2008. Coface recently conducted a survey on corporate risk management to which 1000 Chinese companies responded.
Coface notes that as growth expectations have slowed, and customer credit payment experience has weakened, Chinese firms have tightened their customer credit requirements. Yet 80% of survey respondents experienced overdue payments in 2015, while 58% reported an increase in the amount of overdues.
Not only are Chinese companies having to deal with overcapacity and high leverage, they have also now been hit with a devalued currency and a dangerously volatile stock market.
The Outlook
There are thus those who believes China is heading into a storm, CBA’s economists note, fuelled by the high debt ratio, manufacturing overcapacity, a housing bubble and large non-performing loans hidden in the banking system. And worse, they don’t believe Beijing can see it coming. After a period of such strong economic growth, gravity will soon reassert itself, and China’s economy will fall back to earth with a crash.
There are also those who shrug of such scaremongering. China’s economy can continue to grow rapidly for many years yet, they believe, thus maintaining a gap between growth and the issues chasing behind. China boasts a high savings rate, large foreign exchange reserves (a comfortable US$3.2trn by Deutsche Bank’s calculation), and a fast-growing middle class. The rapid growth of China’s service industry to over 50% of GDP is an indication Beijing’s reforms are working, and there is still huge growth potential in China’s inland regions which is yet to be unlocked.
CBA’s economists, and others, sit in a camp between the China bulls and bears. In five years’ time, China’s economy will be growing by 5-6% but will be more “accident prone”, CBA believes. Longer term growth drivers of productivity and an increasing labour force are now fading. CBA does not expect China’s economy to collapse, but does acknowledge the problems.
“Much of China’s future growth path,” says CBA’ “will depend on the government’s willingness and ability to push through further structural reforms”.
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