China has again announced fast growth with low inflation. And again, the People’s Republic of China (PRC) will be widely praised as a future, or even current, economic superpower. However, other facts have not changed, and in these instances stability is not a laudable goal.
Once more, there are inconsistencies in the most basic and prominent official Chinese data. To the extent official data are reflective, persistent imbalances within the economy are no smaller and may be worsening. The loan stimulus so effective in pushing the PRC past an economic rough patch has now faded. Growth, while still strong, is waning as the stimulus fades, highlighting another round of damage inflicted on the financial system.
China’s GDP officially rose 11.1 percent year-on-year in price-adjusted terms in the first six months of the year to almost US$2.54 trillion. As expected, second-quarter growth decelerated, to 10.3 percent. The consumer price index rose 2.6 percent, completing a picture of slower, but still rapid growth along with contained inflation.
A second glance is troubling, though. The arithmetic comparison of GDP in the first half of the year with GDP in the same period last year shows a nominal gain of 23.6 percent. The difference between nominal and price-adjusted, or “real,” growth is the GDP deflator. The deflator measures price increases at 12.5 percent, sharply at odds with consumer inflation.
An explanation is in China’s data revisions. Beijing issues economic numbers only two weeks after a quarter ends, an impossible feat in the world’s most populous country. One correction for the premature data is supposed to be revisions, but these have not been helpful. China only revises GDP growth higher and does not revise most of its other figures, so revisions render most statistics on the Chinese economy incomparable.
The revisions last year seemed better. Overall GDP growth was raised, again, from 8.7 percent to 9.1 percent, but for the first time, quarterly breakdowns were provided. These show higher GDP in the first half of last year, lower year-on-year nominal growth of 16.7 percent for this year and a reasonable GDP deflator of 5.6 percent.
However, it seems odd for such a small revision to real growth to correspond with such a dramatic change in the deflator. It turns out that although the revisions entailed a sizable decrease in the initial level of GDP for the fourth quarter of last year, there was no corresponding decrease in real growth for the quarter. One way to represent that disparity is a considerable and convenient after-the-fact reduction in the GDP deflator. It may be that China simply moved an important statistical discrepancy away from the spotlight.
Prices also influence the major components of GDP. China’s National Bureau of Statistics provides poor measurements for investment and consumption, releasing better indicators less frequently and very late. Fixed-asset investment rose 25 percent to US$1.68 trillion — equal to almost two-thirds of GDP, a ratio that climbs as the year goes on. Investment growth is nominal, and real growth would be lower by an unspecified amount.
Retail sales — the official benchmark for consumption — were said to gain 18 percent to US$920 billion. Nominal sales growth was near 24 percent (unrevised). While this matches investment, the gap between the sizes of investment and of consumption in the first half of the calendar year has ballooned past US$750 billion. Stimulus was investment driven and worsened this imbalance. There are also powerful reasons at the sector level to worry about comparatively inadequate consumption, despite its robust growth.
Autos are held up as a stunning consumer success, yet demand cannot match supply. As incentives expire, sales growth is well short of output: Sales gained more than 30 percent in the first half of the year to 7.2 million units, while output surged almost 45 percent to 8.5 million units. There may also be more data issues. Passenger vehicle sales soared 77 percent in the first quarter, but gasoline demand edged up only 3 percent.
Other areas of oversupply are well-known. Steel overcapacity is close to 250 million tonnes, while retrenchment plans address only 25 million tonnes. Domestic overcapacity in cement is headed past 1 billion tonnes. Consolidation of cement, autos and other industries have sputtered, as the primary goal is to enhance the position of selected state firms, rather than curb capacity. Heavy industry is the top user of electricity, so it is no surprise that first-half electricity consumption rose more than 21 percent — twice as fast as GDP — past 2 trillion kilowatt-hours. Industrial consumption rose 24 percent and comprised three-fourths of this first-half electricity use.
In the financial equivalent of overcapacity, real estate has an unsustainable role in the economy. The ratio of the housing stock compared with the GDP is higher than the US in 2006, before the bubble burst. Yet in the first quarter of this year, loans for property were nearly a third of total lending and growing twice as fast. For the first half as a whole, real estate investment expanded 38 percent, easily outrunning overall investment, which was itself too rapid. The value of land purchases skyrocketed 84 percent.
Properly speculation ties immediately to banks. The financial system was unsound before the crisis. Pre-crisis estimates of government aid to banks ranged up to US$650 billion. And this solved only the easy problem. Banks still routinely made, then hid, non-commercial loans. In September last year, the Chinese Ministry of Finance itself did the same on a vast scale, rescheduling a US$36 billion bond held by giant China Construction Bank, which accounted for half its net assets. Cinda Asset Management sold the bond to help absorb the bank’s bad debts, then survived on handouts from China’s central bank. China Construction Bank can claim adequate capital, but only because of more government assistance. The largest state bank, Industrial and Commercial Bank of China, holds US$46 billion in bonds of the same type.
Enter the US$586 billion stimulus program. Provinces were to spend two-thirds, but many wanted far more. A few weeks after the stimulus was announced, provincial spending plans reached US$1.47 trillion. By law, local governments cannot report budget deficits, so the stimulus had to come largely through banks. Official data have local government debt last year alone rising 70 percent to US$1.08 trillion, or more than 20 percent of GDP. In comparison, 20 percent of US GDP is US$2.8 trillion — two years of current federal deficits. Beijing attacked local borrowing, but more still occurred in the first half of this year. Just a partial government audit found seven provinces with larger debt than annual revenue.
Finally, since 2007, banks have transferred loans to investment trusts, moving them off their own balance sheets. Transfers were banned at the end of last month, but an estimated US$300 billion in assets were moved in the preceding nine months alone. Banks do not hide excellent assets, and the ultimate rate of failure for transferred assets may be high.
Lack of transparency clouds the question of system solvency, but there are hints. In early spring — before the damage was finished, much less tallied — the four largest listed banks needed US$70 billion in fresh capital. Chinese banks chiefly raise money, through rights offerings or subordinated debt, from other Chinese banks. For the past decade, smaller banks grew faster than the large listed banks. Faster lending in a slower economy generally makes for weaker balance sheets, and larger banks have received far more government aid. The large listed banks may be turning to even shakier allies for help.
More ominous is that the government, too, seeks funds. Many government bank stakes are held in an entity known as Central Huijin, which assist with banks’ needed fundraising. However, Central Huijin has to raise capital to buy bonds and stock from its charges. The main purchasers of its bonds will be banks themselves. The central government is turning for capital to a system turning to the central government for capital.
To be clear, there is no imminent crisis. Bad debts will accrue this year and next. They should appear on bank books next year and in 2012, and the inevitable bailout will start no later than 2014. The wisdom of the stimulus cannot be fully judged until then.
For now, a slower economy suffering financial strain may turn Beijing toward enhancing prosperity with less state spending. More open investment and trade offer exactly that. While foreign attention is focused on the exchange rate and trade trends, China has finally moved a bit toward internationalizing the yuan. A trial program to use yuan in trade was greatly expanded. The trade program is quite substantial, but it can achieve little without a means of investing held yuan. Such a means is now under consideration.
It is thus conceivable that the autumn meetings of the US-China Joint Commission on Commerce and Trade could actually be fruitful. Longstanding US calls for balance of payments reform might be heeded. For its part, the US should pledge an end to simultaneous application of countervailing and anti-dumping duties on Chinese goods or to make investment regulations more transparent.
Derek Scissors is a research fellow in Asian economic policy at the Heritage Foundation’s Asian Studies Center.
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