China will keep its economic policies steady next year in the face of growing uncertainty over the prospects of the world economy and its own leadership transition. At the same time, it is signaling that it stands ready to stimulate the economy through increased social spending and tax changes to promote domestic consumption should the worst prognostications of an “extremely grim and complicated” outlook for the global economy, and particularly its developed-economy export markets, come to pass.
After the conclusion of the three-day annual central economic work conference, which brings together the country’s top central and provincial economic planners, the heads of its biggest state companies, senior PLA officers and top leaders (both the president and prime minister attend), state media reported that:
China will ensure that macroeconomic regulation policies and overall consumer prices will remain basically stable and will guarantee the steady growth of the economy and maintain social stability.
Post-meeting statements from the annual work meeting rarely add little that isn’t in the current five-year plan, and are most profitably read for tone. This year’s does not reflect the sharp debate over where the balance between macroeconomic policies to promote growth and those to fight inflation should fall, with the extent to which measures to cool the property market should continue acting as its proxy.
With inflation slowing, if still elevated, and growth next year possibly falling below 9% for the first time in a decade the pendulum is swinging towards more expansionary policy, but ever so slowly. The decision to continue next year the measures imposed to cool the property market, “to ensure housing prices return to a reasonable level”, even though real estate accounts for 15% of GDP, indicates that the go-for-growthers didn’t have the argument all their own way. The debt incurred from the infrastructure splurge from the previous round of stimulus spending casts a long, grim shadow of its own–as is the specter, always frightening to the Party’s leadership, of social unrest such as that playing out in Wukan.
The larger-than-expected fall in China’s inflation rate will rekindle expectations of monetary easing. Consumer price inflation fell to 4.2% year-on-year, its lowest level in 14 months. Though down from July’s peak of 6.5%, inflation is still running ahead of the government’s full-year target of 4%. GDP growth of 9.1% in the third quarter was the slowest in two years. Manufacturing contracted last month for the first time since 2008 and policymakers have been increasingly vocal in their concerns about the lack of demand in China’s export markets in the U.S. and Europe. However, while the decline in inflation – and the cooling of the real estate market – gives policymakers more leeway to stimulate the economy in the face of falling external demand, unless it collapses catastrophically, we expect them to be cautious about further easing, and especially until after the annual work meeting of the country’s senior economic planners this month.
This Bystander is hardly cheered, if not surprised, to read this report via Bloomberg:
China’s local government debt may be almost 3 trillion yuan ($473 billion) higher than the figure given by the nation’s audit office, if loans taken out by township governments are included, the Economic Observer reported, citing research from an independent institute.
Borrowing by townships, an administrative tier of government below provinces, cities and counties, wasn’t included in a report by the National Audit Office in June that put debt from those three levels at 10.7 trillion yuan, the weekly newspaper said in a report on its website dated Nov. 12, citing Beijing Fost Economic Consulting Company.
At a total of 13.7 trillion yuan, or $2.2 trillion for those of you keeping score at home, that is only chump change at that level off Italy’s outstanding sovereign debt ($2.6 trillion). We’ve seen how these ticking debt bombs can upset markets and oust political leaders. China is fortunate not to have a democratically elected government that investors could force to resign, as they did in Italy and Greece.
Consumer price inflation remains persistently high, though it has eased from July’s peak of 6.5%. September’s number came in at 6.1%, against August’s 6.2%. The summer’s storms and droughts kept food price rises from moderating. The food component of the inflation figure rose 13.4% in September, as it had in August.
With the global economic outlook still uncertain, policymakers at the People’s Bank of China are likely to maintain their policy tightening on hold, but this latest set of monthly numbers won’t do enough to lower inflationary expectations to give this Bystander any confidence that there won’t be another round of interest rate rises or bank capital reserve increases.
James Kynge, of the FT’s China Confidential, writing in the parent newspaper at the weekend, makes grim reading for any European or American policymaker hoping that a second Beijing stimulus would be able to pull the world economy though its latest sluggishness:
The sustained haemorrhage of state bank deposits has swelled the unregulated shadow banking system to such a size that it now supplies more credit to the economy each month than the formal banks do, according to China Confidential, a research service at the Financial Times. This means that Beijing, which has wielded financial control as a key tool of Communist party power, now finds itself largely at the mercy of an unregulated collection of trust companies, private banks, kerb lenders and loan sharks.
Even allowing that China’s trust banks, the largest part of the shadow banking system, are registered businesses and in hock to the big state owned banks — although that is a double-edged sword; which is tail and which is dog? — and there is some local-official sway over some local underground lenders, central economic policymakers are unlikely in the new circumstances in which then find themselves to be able to replicate the instant growth they stimulated with cheap state-driven credit in 2009.
A larger concern is that even if policymakers wanted to use the large state-owned banks to deploy Stimulus Two, the banks are in no shape bank to put it into effect. Beijing has already moved to shore up the big banks’ balance sheets. Central Huijin, the domestic arm of the country’s sovereign wealth fund, started buying shares in the country’s four largest banks on Monday to “support [their] healthy operations” and “stabilise the share prices”.
Central Huijin is already the majority shareholder in the Industrial and Commercial Bank of China, China Construction Bank, Bank of China and Agricultural Bank of China. Investors have been increasingly jittery about the balance-sheet strength of the big state-owned banks, fearing they are carrying potentially too much bad debt from the loans made since 2008 in the cause of Stimulus One.
China’s latest quarterly growth figures show the economy’s growth is slowing at a measured pace, which should reassure investors worried about the possibility of a bumpier deceleration. Year-on-year growth for the second quarter was 9.5%, down from 9.7% in the first quarter and generally beating analysts expectations. There is always a slightly malleable soft focus to China’s published GDP numbers. While the latest set will certainly reflect the trend of a slowing economy seen in a range of other monthly indicators, they may well be erring on the side of the comforting in doing so. For Beijing’s policymakers, investor expectations are just another component of managing a soft landing for the economy as a whole.
Have we seen the last interest rate rise for the year? A consensus is emerging among analysts that we have with the fifth raising of interest rates in eight months.
The Peoples’ Bank of China raised one-year lending rates by 25 basis points to 6.56% from Thursday, while one-year deposit rates went up by the same amount to 3.5%. The end-of-the-liners’ underlying assumption is that inflation will peak in June or July (June’s figure is due next week) and then moderate with falling food prices, letting policy makers switch their attention to the slowing of the economy, possibly heralding stimulative fiscal measures with added investment in property and infrastructure (we continue to be skeptical that those are needed; real negative interest rates, even with the latest increase, will take care of pumping property up).
While we follow the arc of the argument, we are not sure about its timing. Inflation may linger long enough for another step rise in rates to be warranted. Lingering even more menacingly in the background is also the fear that the local government debt bomb might get triggered if rates rise too far, making even more of the debt non-performing. Higher capital reserve ratios for the banks are likely to be doing the heavy lifting for monetary policy for the rest of the year.
The audit of China’s local government debt paints a reasonably reassuring picture. The question is how complete that picture is.
The National Audit Office put the debt at 10.7 trillion yuan ($1.7 trillion) at the end of 2010. That is 27% of GDP, far lower than the worst expectations (this is the first time the numbers have been made public). It is also much higher than the central government’s debt of 17% of GDP. Add in all the usual liabilities that goes into a country’s public debt number and China is looking at an overall number of 80-90% of GDP, not particularly high by international standards but in such a state-centric economy, it will all come back to central government one way or another.
Much of Beijing’s stimulus package in response to the 2008 global financial crisis flowed through local government spending on public works. Local government debt rose by 62% in 2009 over the previous year, as local authorities laded up with bank debt (and the banks, state owned, with potential bad debt). The borrowing increased by a further 19% in 2010.
It also encouraged the widespread use of special investment vehicles to get round restrictions on borrowing. The audit says that there were 6,576 such vehicles, with a combined debt of $5 trillion. Yet this shadow financing system is only partially accounted for by the audit. Only loans explicitly guaranteed by local governments has been included. Beijing is already reported to be planning to shore up local government finances with a 2 trillion-3 trillion bailout to cover the 23% of the lending to projects with neither collateral nor viable cash-flow to cover their debt service (this bailout could include some securitization of loans for resale to private investors or through the bond market). In addition, the central bank has told banks to increase their capital reserves against similar projects that are only generating sufficient cash flow to service part of their debt.
The situation seems manageable for now, though central policy makers’ concern remains acute as they work on defusing the debt bomb. Most local-government debt has long maturities and fiscal and land revenues have been strong, even if land sale revenues are now softening. The risk of a local government debt default remains low–as long as economic growth remains brisk and the state-owned banks can be made to absorb some of the worst bad debts. The tick-tock of the debt bomb may be getting a bit less audible but it is still there.
More confirmation that the economy is maintaining its momentum, and policymakers a degree of nervousness. The People’s Bank of China has again raised its capital reserve requirement for the big banks, the sixth and latest of its step increases as the central bank continues to tighten monetary policy. The capital reserve ratio will be increased to a record 21.5% from June 20th.
The central bank made the announcement in the immediate aftermath of the publication of May’s consumer price inflation number, which at 5.5% is the highest in almost three years. The one following the other so quickly was unusual, but the central bank may have been attempting a little inflation expectation management combined with sopping up some of the foreign-exchange inflows that will have come with a resumption of trade surpluses in April and May. Nonetheless, the inflation number may be of more pressing political than economic concern, if the weekend’s riots in Zengcheng are any indication. Food price inflation in May was 11.7%.
The economy’s growth is moderating in a far more comfortable way for policymakers as the rate of new bank lending and money-supply growth is slowly but surely reined in. May’s greater than expected rise in industrial production and the slight rise in retail sales also suggests that the economy is maintaining enough momentum to take another step rise in interest rates, which would be the fifth since last September, in its stride.
To our mind, the new bank lending numbers, for the first five months of this year, and the slowest expansion of credit since 2008, do not signal much by way of a slowdown in the economy, or at least not by as much as some commentators suggest. Our sense is much more that central government is enforcing its lending quotas on local governments more effectively than it has done in the past, as well as shifting some money into capital reserves as a result of higher capital ratio requirements imposed on the big banks.
We also note that the money supply, on its broad M2 measure, was still up 15.1% in May over the same point a year ago. Inflation is still persistently and unacceptably high, suggesting further interest rate rises are likely. Growth will be kept robust enough to absorb them.
That all said, as bank lending quotas are one of the best of the few tools of monetary policy that the central bank possesses, we are seeing some reigning in of the expansionary stimulus that followed the 2008 global financial crisis, as is central bank policy. Yet, as ever, what the government takes away, it can give back if circumstances demand it.