THE New Year started not with a bang but a whimper. International Monetary Fund
(IMF) managing director Christine Lagarde’s prognosis at the end of 2015 was that
global growth in 2016 would be “disappointing and patchy”, blaming rising US
interest rates, the economic slowdown in China, persistent financial fragility in several
countries and lower oil and commodity prices.
Sure enough, on the first day of market opening on Monday, the Shanghai A share
market fell 7% (and again on Thursday), dragging global stock markets with it. The
dominant story in 2015 was the slowdown of the Chinese economy and its impact on
global commodity prices, including demand on luxury goods. Would this trend
continue into 2016?
The IMF 2015 Article IV consultation on China, arguably the best available official
“health-check report”, commented in August last year that China was “transitioning to
a new normal, with slower yet safer and more sustainable growth”.
Growth in 2014 fell to 7.4% and was forecast to slow further to 6.8% in 2015. Sure
enough, by October, the IMF World Economic Outlook forecast was 6.3% for 2016,
not bad by any standards, but slower than India (7.5%), currently the darling of
foreign investors.
There are good reasons for being cautious because of the rising risks. The foreign
press analyses of the Chinese economy are almost uniformly pessimistic. Not only do
they think that there will be a hard landing, several analysts think that a financial
crash is inevitable.
The facts are quite clear on the risks. Firstly, between 2008 and 2014, China’s
private debt to gross domestic product (GDP) ratio rose by 73 percentage points. The
famous Reinhart and Rogoff (2009) book, “This Time is Different” suggested that fast
rising private debt is the best indicator of financial crises and in the last five years,
Chinese debt has grown fastest in terms of total debt.
Downward signal
Secondly, the economy is clearly slowing with both manufacturing and recently
service sector indicators showing negative or slowdown. Thirdly, since July last year,
despite market intervention, the stock market index is still signalling downwards.
Bank of America Merrill Lynch analysts are predicting a Shanghai Composite Index
level of 2,600 for 2016, compared with peak levels of 5,178 in June last year and
current levels of 3,100. Fourthly, there are capital outflows and concerns on yuan
depreciation.
On the plus side, proponents argue that so far, the labour market has remained
resilient because of the shift towards a more labour-intensive service sector.
Household consumption has remained fairly firm, whilst inflation has been flat, helped
by lower commodity and energy prices.
Unlike advanced countries, Chinese fiscal policy has much more room to manoeuvre,
because total government debt was still less than 60% of GDP at the end of 2014. By
allowing more interest rate and exchange rate flexibility, the room to use monetary
policy by the People’s Bank has been strengthened.
Despite concerns about the rising level of non-performing loans, the largely state-
owned Chinese banking system has adequate capital to absorb these, and those of
the shadow banks, which are slowly but surely being brought within the regulatory
network.
Up to latest available data, credit and total social financing has decelerated, but there
are no signs of abnormal illiquidity or debt deflation, since the property market has
shown some signs of uptick in first-tier cities.
On the external front, the balance of payments current account remained a surplus at
2.1% of GDP, which offset the capital outflows as indicated by the loss in foreign
exchange reserves.
Long-term perspective
Because the economy is so large, looking at China requires a long term perspective
than normal. The New Normal is that the Chinese economy is slowing naturally as
the economy grows larger and the median age increases. Under the 13th Five Year
Plan, the economy is being re-tooled to become a domestic consumption driven,
innovation and service driven, open economy that aspires for social inclusivity and
environmental sustainability.
The mantra on the supply-side adjustment is all about getting rid of excess
manufacturing capacity and moving to energy and resource efficiency. The AIIB, yuan
joining SDR and Chinese aid to Africa and global climate change initiatives also imply
that China will contribute towards global public goods.
All these aspirations must be achieved within the context of social and financial
stability. No economy in the world has attempted all these ambitious goals
simultaneously without some trade-offs. In such a massive transformation in scale
and short time frame, some economic, financial or political pain is inevitable.
Seen from this perspective, the key question for China is whether the economic
trajectory is J or L-shaped. In other words, are the reforms aiming for a short
correction followed by a more sustainable long-term growth, or will China join the rest
of the world in a global secular stagnation phase?
China’s debt problem is unique in that it is largely a domestic debt overhang, with
state-owned banks lending mostly to state-owned enterprises with no net debt owing
to foreigners.
I have argued that since local governments and SOEs still own considerable net
assets, now is the time to re-write the national balance sheet with debt-equity swaps
to cut back the debt and restore balance in the corporate leverage situation. The
state-led system can deal with its state-driven debt problem.
But one factor to consider in the current system is whether the political cycle is in
sync with the economic cycle. The anti-corruption campaign, which is designed to
restore integrity and trust in the cadre system, has now pulled in a number of
businessmen, which creates uncertainty whether public and investor confidence can
be “business as usual”.
Complex mix
The level of the stock market index is only an indicator of the complex mix of investor
greed and fear. Just as GDP is no longer adequate as a benchmark of economic
progress, policies and business decisions benchmarked against a stock market index
can only be wrong.
Tough decisions will have to be taken in 2016 to ensure that the long-term
aspirations of the 13th Five Year Plan can be achieved.
Andrew Sheng is Distinguished Fellow at the Asia Global Institute, University
of Hong Kong.
A version of this article appeared in The Star Online, 9 January 2016
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