14 January 2014
Forecasting is a mug's game, but we can't resist. Economists usually take a stab at the central growth forecast and then add a shopping-list of things that might go wrong. If you enumerate enough risks, there are built-in excuses when the central forecast doesn't happen.
Inscrutable China provides a popular down-side risk for global growth forecasters. Some prophets have been predicting a crisis for years. Andy Xie is still awaiting China's collapse. Michael Pettis' bet with The Economist that China would average only 3% growth this decade looks more outlandish with each passing year: on current growth rates, China will double its income this decade. How wrong do you have to be before you lose your expert status?
Now George Soros, the man who broke the Bank of England in 1992, has joined the chorus, saying that ‘the major uncertainty facing the world today is not the euro but the future direction of China’.
There are two interwoven threads in this story. One is China's growing financial fragility and debt burden, especially the borrowings of local authorities. These local governments did most of the heavy lifting in the 2008 fiscal stimulus, with an infrastructure building spree that left them with hefty debt. The second element is the need to rebalance the economy, pulling back on investment (currently half of GDP) and expanding consumption (currently only 36% of GDP, whereas in most countries it would be nearly twice that).
There is no dispute that both these issues need correction. The latest National Audit Office figures show local government debt equal to a third of GDP and rising; adding central government debt takes the debt total to 56% of GDP. Nor is there any doubt that consumption has to become the main driver of growth.
These changes seem eminently achievable. The Chinese authorities have already introduced new regulations to rein in local government borrowing. Moreover, there is time to make the changes.
China's government debt is not much more than half of the OECD average, and within the OECD there are half a dozen countries teetering on the brink of crisis, with twice China’s debt and fragile governments lacking Beijing's capacity to bring about change.
In winding debt down, it also helps if your interest rate is low (China's rate is half the European peripheral countries’ borrowing rate) and you are growing quickly (China is growing three times as fast as Europe). And Chinese local governments can argue that at least their debt was used to create some socially useful assets, not just to fund unsustainable social expenditures.
At the institutional and macro level, China is well placed. Its debt is denominated in local currency, it has an external surplus, capital flows are tightly controlled, the banks are largely state-owned and fast growth smooths reform and restructuring. When it comes to predicting financial disaster, some commentators just don't understand where the financial risks reside, confusing minor operational issues with portents of disaster.
Financial markets pressed the panic button in June and again in December when interest rates in the short-term inter-bank market spiked sharply. This isn't a sign of impending financial crisis; it's just the central bank signaling, in a clumsy way, that credit is growing too fast. In each case the bank quickly eased off when the signal was disruptive.
What of the need to restructure, away from investment and towards more consumption? If you told European politicians that their main challenge was to rein in an overly dynamic investment sector and persuade the public to consume more, they would wonder where the problem was. Consumption is already growing a bit faster than GDP. Boosting this further requires the politically delicate task of shifting income from the state-owned enterprises and redistributing this to the workers. Tricky, but a lot easier than Europe’s task of drastically cutting social expenditures and raising taxes.
China has already shown a great capacity for readjustment. Four years ago, the list of issues China had to correct was headed by the current account surplus (running at 10% of GDP) and a growth strategy which relied heavily on export promotion. Since then, China's growth has not relied at all on export growth (the value of imports has risen faster than the value of exports) and the current account surplus is down to 2% of GDP.
China still has unfinished business. No doubt the bad debts in the financial system are far greater than officially recorded and official debt is bigger. Doubtless some of the huge investment surge will turn out to be unproductive. Beijing may not have close control over the debt activities of local governments. Its 'augmented budget deficit' is around 10% of GDP, which is unsustainable.
Even with good policies, China's sustainable growth rate is now 7% rather than 10%. But if we note Europe's problems, where growth is feeble, unemployment is over 12%, excessive budget deficits are chronic, the peripheral countries can't recover without substantial debt rescheduling, and above all politics is dysfunctional, Soros' spotlight on China rather than Europe seems a bold call.
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