Peter Cai, Business Spectator, 23 December 2015
CHINA – Back in 2014, the most searched phrases made on Google about China’s economy were ‘China largest economy’, ‘China number 1 economy’ and ‘China overtakes US economy’. That changed in 2015: people increasingly looked up phrases such as ‘China economy collapse’, ‘China economy crash’ and ‘China economy crisis’.
The China narrative has changed decisively in 2015. There has never been so much pessimism about the world’s second largest economy, which has been the principal engine of growth for the world economy for the past decade.
The turning point, if one could be pinpointed, was around the midyear $5 trillion stockmarket rout and the failed rescue mission.
Though the stockmarket crash had a limited impact on the country’s economy, the psychological damage has been far more pronounced.
The rout has led many people to question the competence of Chinese economic policymakers, whose record had been quite exemplary. The failed intervention to boost the stockmarket has been widely condemned both in and outside of the country. In the end, unruly market forces humbled the mighty Chinese Communist Party.
After the failed stockmarket intervention, the Chinese central bank decided to adopt a flexible exchange rate regime, which led to depreciation of the yuan. The market widely interpreted the move as an attempt to boost the competitiveness of the country’s sluggish export sector. The move sparked worldwide sell-offs.
These two events have helped to change the prevailing narrative about China. However, there are more important fundamental forces at play in 2015.
The most important is the continued weakness in the country’s once mighty manufacturing industry. The sector is besieged with problems such as weak demand, high wages and excess capacity.
The Chinese leadership has identified excess industrial capacity as the number one problem for the country to resolve in 2016. Many companies in these sectors with excess capacity are turning into ‘zombie companies’, on life support from local governments and the state-owned banking system.
These ‘zombie companies’ are transmitting their disease to the Chinese banking sector. The proportion of bad loans is increasing rapidly on their balance sheets. Beijing is trying to prevent a systematic financial crisis from happening.
Beijing has undertaken some important steps to address the problem of burgeoning local government debts. Chinese auditors, finance ministry officials and regulators are closer to getting to know the true size of the country’s debt problem. More importantly, the government is implementing a large-scale debt swap program.
Beijing will swap short-term high yield local government borrowings with long-term low interest rate government bonds. Though the move will solve the debt problem, it will give local government crucial breathing space to repair its balance sheets. Local government debt will remain a thorny issue for the foreseeable future.
One bright spot in China is the gradual restructuring of the economy. The services sector is providing much-needed growth momentum to prop up an otherwise struggling economy. Many sectors such as e-commerce, entertainment and healthcare are going gangbusters. A consumption boom is underpinning the expansion of the services sector.
China’s retail sales have been growing at more than 10 per cent this year. Chinese shoppers are opening their wallets and keeping the economy ticking along. Wages growth in the country is also strong. Meanwhile, the country has been running out of surplus labourers for some time.
Beijing is also rolling out a suite of measures to support innovation. Tens of thousands of start-ups have been created in China this year. This reporter has visited many innovation centres in China: in cities from Beijing to Guiyang, young Chinese tech aspirants are dreaming big dreams. It is still early days to see whether this innovation craze will turn grow into something substantial.
It has been two years since Beijing introduced its ambitious reform package. So far, progress has been limited. Caixin, a respected business magazine, estimates the government is only making solid progress in one fifth of its reform program, while the rest of reform agenda is either stuck in the slow lane or stalled.
The Chinese government has made considerable progress in financial sector reform, liberalising both the interest rate and the exchange rate. These are significant changes, ending a decades-old policy of financial repression that discriminates against savers in favour of banks.
Beijing has also ended the controversial one child policy in recognition that the country is staring down at the barrel of a looming demographic crisis. Most of economists, analysts and demographers agree the change is too little too late. One of the biggest long-term challenges for the country is the ageing population.
In 2015, Beijing has managed to muddle through another difficult year and there is a growing recognition that unless the government implements far-reaching reform program, the country is simply delaying a full-blown economic crisis.
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