China reported last week that its economy grew at 6.7% in the third quarter compared with a year ago.
That’s bang on the money where most analysts had expected it to be and was identical to the GDP figures posted in the first and second quarters of the year. The consistent numbers have caused some to question the accuracy. A New York Times article suggests that a lending binge in China this year has helped to sustain growth and create some uplift for the property market.
Whether you believe the numbers or not, the long-term trend is slowing growth in China and this year’s will be the weakest In 25 years. Unfortunately, it’s not just China, global growth is slowing and global GDP forecasts have been repeatedly downgraded this year not just because of China, but because of the depth of the recession in Brazil and Russia and a lack of growth in the E.U. and Japan. The article quotes an economist at Enodo Economics who says “the economy has reached the end of the road when it comes to its export and investment-led growth model.” If that is the case, the question is what comes next?
Slowing Growth
The NY Times posts three possible scenarios, none of them particularly attractive.
The first is financial meltdown as a result of a debt crisis. China’s version of the 2008 financial crisis that plunged the U.S. into a recession. Last month, the Bank for International Settlements published new data estimating that the gap between China’s outstanding credit and its long-term economic growth rate had widened to a record, the New York Times said, and was well above the historical level that indicates financial crisis is likely.
Loans Coming Due
In a report this month the IMF warned that shadow loans average almost 300% of the capital buffers at China’s smaller banks, prompting the fund to warn of the risk of financial calamity in China. Even so, most analysts would accept that the risks of a financial meltdown remain relatively low. Beijing has a tight grip on its financial system and controls not only the big banks but the big companies that borrow the most. It has substantial reserves and can manage a crisis at today’s level of borrowing. However, if it fails to get a grip on credit growth by the early part of the next decade the problem may have ballooned beyond even Beijing’s ability to manage it. In the short term, financial meltdown remains unlikely.
The second option the article suggests is the China could just spend its way out of it slowdown, much as it did in 2009-10 after the last financial crisis. One problem the paper has identified, though, is that the government is getting incrementally less back for every additional dollar of investment, simply adding to a stock of underperforming loans.
Private companies are being put off from investment by the poor economic outlook and are pulling back on domestic expansion. This year’s state spending has helped keep growth rates up, but with the debt markets desperately needing restructuring and capacity rationalization needed in many major state-controlled industries, there are limits to where productive investment can be made.
Lost Decades
The final outcome the article explores is a future more akin to that of Japan. The paper quotes Arthur R. Kroeber, the managing director of Gavekal Dragonomics when it says ”just having a lot of debt, and bad debt, does not cause you to have a crisis. But the price that you pay — if you don’t do the financial restructuring and real economy restructuring that is necessary to restore things to health — is that you get a very long period of very low growth and anaemic activity,” this is exactly the situation that Japan found itself then in the 1990s and subsequently led to the lost decade of growth that that previously dynamic economy achieved.
China doesn’t yet have Japan’s aging demographic but it will soon and while a decade of slow or mediocre growth would not be a disaster it would reduce the impact of one of the worlds principal engines of growth over the last 10 years.
What we should accept is that China will progressively contribute less to global growth than it has done in the past, although it should not be forgotten if 6.7% really is China’s current GDP, it’s the equivalent of double-digit growth in the last decade simply because China’s economy is so much larger now than it was at that time.
by Stuart Burns