Lower growth can tame risk of ‘gray rhinos’ in China

By Shen Jianguang Source:Global Times Published: 2018/2/5 22:23:40

Illustration: Peter C. Espina/GT

As socialism with Chinese characteristics has entered a new era, the nation's economy has turned out to have two distinct sides. On the one hand, the economy is seen to be stabilizing, with indicators for 2017 beating expectations. The three wagons pulling the economy - investment, exports and consumption - all gained steam over the past year, while the new economy flourished.

On the other hand, local debt risks have grown, and many provincial-level regions and cities have admitted inflating their GDP and fiscal numbers. The financial industry is also rife with risks. In a striking example, the Chengdu branch of Shanghai Pudong Development Bank was revealed to have provided more than 70 billion yuan ($11.11 billion) in loans illegally to shell companies.

In addition, bubbles are piling up in the property market and tightening measures that restrict home purchases, loans and sales, among others, are still indispensable to curb property investment.

Understanding the dual realities of the economy will cast light on the challenges the economy faces.

There were heated arguments last year over whether the economy's rebound resulted from a new cycle of economic growth or an old growth model. I would argue that both helped in propping up the economy.

For one thing, investment in infrastructure and real estate has played an important part in steadying the economy. Meanwhile, owing to a global economic recovery, net exports contributed 0.6 percentage point to GDP growth last year.

For another, the new economy, powered by the Internet Plus policy and based on big data, cloud computing and artificial intelligence (AI), has rapidly risen to prominence. China's mobile payment applications have taken the lead globally, dramatically reducing transaction costs and increasing the economy's operational efficiency.

AI is developing rapidly in China and the country's robotics sector is growing fast. China's industrial robot output accounts for one-third of the world's total. Also, e-commerce is expanding much faster than overall retail sales. It can be said that the new economy is remaking traditional business models and becoming a significant growth engine of China's economy in the new era.

In light of this, some optimists reckon the economy has entered a new cycle and will continue on the recovery track in 2018, with GDP growth rebounding to 7 percent or even higher. But I would argue that it is less likely the economy will be powered simultaneously by the new growth engine and the old model this year.

The old model, relying on new debt to stimulate investment, helps in stabilizing economic growth in the short term, but the resulting financial risks have grown. This is unsustainable, as there are hidden worries about local government debt, high leverage in both the financial sector and real economy, and property bubbles that could be giant "gray rhinos" weighing on the economy. Amid deleveraging concerns, this year is likely to be filled with uncertainty for China's economy.

First, local government debt risk can't be underestimated. North China's Tianjin Municipality recently admitted falsifying their economic data. Despite supposedly higher fiscal revenues, local government debt continued increasing, with the debt rising beyond local governments' repayment capacity.

Second, local governments raise debts to invest mostly in medium- to long-term infrastructure projects. These take a long time to build and start operating, yet they provide few short-term benefits, thus increasing financial risks.

Third, the financial sector is exposed to greater risks amid the country's deleveraging drive. Since the 19th National Congress of the Communist Party of China, policymakers have clearly delineated their stance favoring tighter rules and deleveraging efforts.

I tend to believe the deleveraging push might increase the probability of a risk incident in the financial sector. At the start of the year, a State-owned investment platform in Southwest China's Yunnan Province was reported to have secured financing after defaulting on two trust loans in December, in the latest sign that State-backed financing vehicles can't guarantee loan repayments. With local governments subject to tighter debt constraints and financial deleveraging underway, it is reckoned that the Yunnan case won't be the only such case this year.

The financial market might seem placid as high leverage is seen as enabling prosperity, but once the government shifts toward policy tightening, it will be quite difficult to cover any problems and the genuine stability and risk-hedging capacity of financial institutions will be a concern.

Apart from that, fixing property bubbles is a tough job. Over the past decade, China's home prices have frequently entered the crosshairs of government controls and yet have continued an overall upward spiral. This has been achieved through a recurring cycle of rising home prices for a certain period, prompting the government to tighten its grip on the housing market, followed by an increase in income that offers a fix for property bubbles.

This cycle is unlikely to continue, however, as home prices in many cities have doubled over the past two years, while income growth has declined.

With policymakers clearly stating that homes are for living in, not for speculation, along with declines in sales and new starts, there will be a gradual slowdown in property investment. Property-related consumption and local government coffers will also be affected, dealing a blow to economic growth. In policy terms, there remains uncertainty over the rollout of a property tax, a key component of any long-term mechanism to regulate the housing market.

In conclusion, the economy's rebound in 2017 lacked a stable foundation. Powered purely by the new dynamics, economic expansion is likely to go on a downward spiral, with GDP growth falling to 6.3 percent in 2018 from last year's 6.9 percent.

The sacrifice of growth in the short run, nevertheless, is a must for "gray rhinos" to be prevented and for there to be higher-quality growth.

The author is chief economist with Mizuho Securities Asia Ltd. bizopinion@globaltimes.com.cn


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