By John Richardson
So, over the last few days, I have been heartened by a change in tone in analysis of China’s economic slowdown. Instead of repeating the old falsehood that, “all we need is a little bit of old-style stimulus to get the economy back on track”, most people now seen to accept that whatever extra stimulus is introduced this year will merely cushion the impact of very painful economic reforms. Better late than never.
A very good example of this shift is how analysts have interpreted a recent initiative to shore-up the real-estate sector: A reduction in down payments on a second home from 70% to 40%.
There is a consensus that this particular measure will do little more than improve sentiment slightly, given that:
- Most of China’s super-rich already own second homes and those who don’t are unlikely to make the plunge, given falling real-estate prices.
- For the rest of China, private property in most of China’s big cities remains way too expensive to even afford a first, never mind a second, home.
Similarly, whilst most people expect further cuts in interest rates (they have already been cut twice since November) and other monetary-easing measures, the majority view is that this will just ease the pain rather than result in a sudden economic turnaround. Servicing existing debts is the bigger issue in China today rather than acquiring new debts, and so lower borrowing costs would only reduce the number of bankruptcies. Lower interest rates simply would not, cannot, encourage a new bout of risk-taking.
The key for me, also – and this is again now gaining much-wider acceptance – is the change in the mood in China, which I first noticed last October. No matter what easing measures the government might or might introduce over the rest of this year, people recognise that more difficult reforms are on the way. This is making them reluctant to both lend and borrow more money.
China’s leaders have repeatedly, since November 2013, made it crystal clear that a lot more pain is on the way, including Prime Minister Li Keqiang who last month said of reforms: “This is not nail-clipping, its wrist slashing. It’s like taking a knife to one’s own flesh”.
The proverbial knife will continue to cut deep into the corruption that has so badly damaged China’s economy. As this article in the Business Insider quite rightly points out:
The country’s super-rich are scared to spend. High-level officials and businessmen are going to jail. And all of it is disrupting the way business has been done in China.
What’s more, many analysts see the drive more as a way for Xi to consolidate power than a way to make China more modern and transparent.
But Xi [Xi Jinping, China’s President] doesn’t care about any of that. Using state media, he has made it clear that any suggestions that his anticorruption campaign is hurting the economy will not be tolerated. And China’s central bank is going to have to figure out another way to get more cash flowing through the economy. The drive will go on.
The anticorruption campaign is not only about getting rid of graft, as the Business Insider indicates, but is also about removing corrupt officials who oppose economic reforms. These include the leadership teams of state-owned enterprise (SOEs), such as PetroChina.
The message to those who run the SOEs is clear: Stop misallocating capital, stop adding to overcapacity in already oversupplied industries and stop adding to our pollution problems. If you continue to do all the above, you will end up in a lot of trouble.”
You have to remember that this type of bad investment has been the main driver of China’s GDP growth, particularly since 2009. Take this growth-driver away and you end up with much-lower real GDP numbers.
It is also crucial to keep in sight the fact that fully replacing this lost investment-driven growth is not going to happen overnight; in all probability, it will take several more years for all sorts of reasons. These include:
- The reluctance to lend and borrow more money, which I have already detailed above. This will hold-up the rebalancing of the economy towards consumer spending and away from bad investment.
- “China’s economic growth model remains inefficient, our capacity for innovation is insufficient, overcapacity is a pronounced problem and the foundation of agriculture is weak,” said Li, in the same “wrist-slashing” speech mentioned above. This lack of innovation applies to the services sector, which, inflation adjusted, lags a long way behind manufacturing.
The fantastic news, though, is that China has plan, a long term. Its leaders are imbued with an iron will to execute this plan, as Xi made clear in a speech on Sunday, during China’s annual economic forum at Boao, on Hainan island, when he said: “China’s economy entering the new normal will continue to provide countries, including Asian nations, [with] more markets, growth, investment and co-operation opportunities.”
By this, he was referring to the China-led Asian Infrastructure Investment Bank (AIIB), which will help fund the New Silk Road. It is in areas like this where the long term future for China lies. Other countries need to sign-up to the AIIB or they will lose out – big time.
But returning to the more immediate economic outlook, China simply has to find a way to protect employment. This is where you can expect major short term shifts in policy that could run counter to its longer-term objectives.
More evidence emerged earlier this week that employment stress is increasing: The employment sub-index of the final HSBC purchasing managers’ index for March was 47.4 (anything below 50 is negative territory).This was the 17th straight month of contraction and the lowest reading since August 2014.
How will China fix this problem? We know this cannot be through domestic growth and so it simply must support exports. This can only mean that China will export more deflation to the rest of the world.