Although I am often surprised by how eagerly foreign commentators have embraced the Chinese fiscal stimulus story and see it as a great, shining success, I am happy to say, mercifully, that in China there is a lot more skepticism. There seems to be a serious debate among Chinese policymakers over the stimulus package.
The debate lists, on one side, people centered on the PBoC, the CBRC and the National Bureau of Statistics, who are worried that the stimulus may be exacerbating Chinese imbalances. On the other side are people in the State Council, the Ministry of Commerce and in the provincial and municipal leadership who are more worried that any half-heartedness will lead to a significant rise in unemployment.
In the past week or so the former, with whom I am of course in complete sympathy, seem to have become increasingly worried and have been making a lot of noise. The formidable Hu Shilu, editor of Caijing, (and by the way Evan Osmos wrote a very interesting article about her in the current New Yorker) recently made a strong case against continuation of the current fiscal program when she wrote in an editorial this week that “a policy that encourages loose lending and investment is driving China’s economic engine down an old, unsustainable path.”
Various signals suggested China’s economy had returned to a stable track by the end of the second quarter, giving us an opportunity to reassess macroeconomic policy. Data released by the National Bureau of Statistics showed that China’s GDP rose 7.1 percent in the first half of the year, and 7.9 percent in the second quarter alone. Apparently, China’s economy has bottomed out.
Arduous efforts contributed to this upward trend. External developments have had a much more serious impact on China’s economy recently than during the Asian Financial Crisis a decade ago. However, first half growth was only a bit below the level recorded in 1998. And although heavily dependant on exports, China may yet achieve its 2009 growth target of 8 percent, even while other major export countries report contractions.
These achievements could intoxicate Chinese policymakers. But we see no miracles here. In fact, economic growth recovery in China is being driven by investment. Some 6.2 percent of the country’s first half GDP growth rate can be credited to investment, while consumption accounted for 3.8 percent. The net export business contributed a minus 2.9 percent to the growth rate figure.
Hu makes the point that the “surprisingly high” Chinese growth is neither surprising nor cause for celebration. It is the automatic outcome of a huge stimulus, and the real question, as I have argued many times, is not whether high current growth indicates that China has turned the corner on the crisis (it most certainly has not, in my opinion), but whether the cost of achieving this growth is excessive and will lead to more difficult conditions in the future.
It’s long been acknowledged that China’s traditional methods of achieving economic growth cannot be sustained. However, we are now racing down this traditional path of economic development.
Dramatic increases in the currency supply and lending have been backing this investment, the single most important engine of economic growth. M2 increased 28.5 percent and yuan-based lending rose 34.4 percent in the first half, setting new records for each. But nominal GDP growth was only 3.8 percent during the first six months of 2009. And these astronomical increases in currency and lending are a double-edged sword that can support GDP growth as well as endanger the economy.
…It’s high time we re-emphasize the actual policy of moderation. A moderately loose monetary policy is necessary for an unpredictable, downward-sloping economy. However, monetary policy that’s too loose will have more drawbacks than merits once an economy levels out. It’s only a matter of time before loose monetary policy leads to inflation and asset bubbles.
She concludes, very diplomatically I think:
In the current economic environment, the more quickly China’s economy grows, the greater the effort needed to adjust future methods of economic development. Now is the right time to consider the timing of exit from stimulus. The third quarter can be a crucial juncture.
She is not alone in criticizing the stimulus. Another formidable lady, Wu Xiaoling, former People’s Bank of China vice governor, was interviewed by National Business Daily on Wednesday, and warned that the combination of excess capacity and excessively loose monetary policy was leading to asset bubbles. According to an article in yesterday’s South China Morning Post,
“Under conditions of overcapacity, excess money supply will not lead to rises in price indexes, but it could generate asset bubbles,” she said at a forum in comments reported by the Chinese-language National Business Daily. ”The money has really gone out and if it is a time when there is no investment in the real economy and no one will put the money in banks to earn interest, then the funds will flow into the property market and stock market,” she said.
China’s central bank may have to raise banks’ reserve requirements to mop up excess liquidity, she said, adding that this was simply a tool for managing the money supply and should not be misunderstood as monetary tightening.
…Ms Wu said that China faced a dilemma in easing the rate of loan growth. Inflationary pressures would arise if lending continued at the same pace, but without sustained lending, many big projects may wind up unfinished because they are contingent on longer-term financing.”
Although an increasingly large number of Chinese academics and think tank researchers have been raising warning cries, I think she is the first official or ex-official to go so public with her worries. That doesn’t mean other public officials don’t act as if they are worried. The CBRC for example announced this week the good news that the NPL ratio declined from 2.42% at the end of 2008 to 1.77% at the end of June.
Part of this reflected an actual decline in NPLs, and most of it of course reflects the surge in new loans, but the CBRC is not acting complacent. They have reinforced credit control policies on second-home purchases and their spokesman insisted earlier this week that there would be “strict enforcement” of the CBRC’s mortgage lending policy.
According to another article in Caijing, “the authorities have consistently been encouraging banks to raise their loan-loss coverage, reflecting fears that the massive surge in new credit extended in the first half may lead to a rise in bad loans.” The South China Morning Post had this to say on that subject:
Beijing has required banks to raise their bad-loan reserve ratio to 150 per cent at the end of the year, forcing the lenders to set aside an additional 70billion yuan ($79HK.4 billion) as provision amid deteriorating asset quality, a fresh sign of China’s mounting worries about a backlash from its stimulus package.
Liu Mingkang, the chairman of the China Banking Regulatory Commission, told a government working conference over the weekend that all mainland-based banks including local units of foreign giants such as Citigroup and HSBC Holdings must boost their reserve ratio to 150 per cent, as risks were increasing amid a torrent of imprudent loans in this year’s first half.
“Rapid growth in banking loans has led to accumulated risks,” Mr Liu was quoted in a CBRC statement as saying. “Reckless operations of banks were seen as some banks rushed to extend loans without due diligence.”
The article goes on to quote She Minhua, a banking analyst at China Jianyin Investment Securities as saying “The requirement is basically a message that asset quality deterioration is deepening. A serious problem will probably surface in 2010.”
And Zhu Hongren, spokesman for the Ministry of Industry & Information Technology, said earlier this week that China, the world’s largest steel producing nation, should curtail “reckless investments” in the industry by withholding project approvals. According to an article in Bloomberg:
China’s demand for steel is about 500 million metric tons, less than the annual output capacity of 660 million tons, Zhu Hongren, spokesman for the Ministry of Industry & Information Technology, said at a conference in Beijing today. Zhu is reiterating figures given by the China Iron & Steel Association in February for last year.
Crude steel output in China rose to a record 266.6 million tons in the first half as the nation’s $586 billion stimulus package spurred demand from builders and carmakers. Annualized, this would beat the 460 million tons output forecast by the steel association for this year.
“The industry must produce according to market needs, and avoid adding to the excess capacity,” Zhu said. “They should avoid reckless investments. The government must also take action to curtail additional investments by companies that are already in excess.”
Even Justin Lin, the World Bank’s chief economist, and someone who has been more of a cheerleader for China’s economic model than a critic, made a statement that suggests to me an indirect criticism of the fiscal stimulus package, although he (and others) may disagree with my interpretation. According to a July 15 article in the Telegraph:
But for all the warnings I don’t want to exaggerate my account of rising skepticism among Chinese economists and regulators. In spite of possible back-door attempts by the PBoC and the CBRC to manage the excesses associated with the fiscal stimulus, it is pretty clear I think that policy is still being managed largely by policymakers who are far more worried about rising unemployment in the short term than about asset bubbles and an exacerbation of the unbalanced development model.
The front page of today’s People’s Daily, for example, makes this clear. They cite Finance Minister Xie Xuren’s insistence that “China will stick to proactive fiscal policy in the second half.” According to the article, which is also carried in Xinhua:
China will continue its proactive policy and reform its economic structure in the second half of this year to boost economic growth, Finance Minister Xie Xuren said Thursday. Xie told local financial bureaus at a conference in Beijing on Thursday that the proactive policies, which included increased investment from government, tax cuts and subsidies to low income families, had taken effect in stimulating a recovery of the national economy.
Xinhua today also prominently cites Peking University professor Li Yining as saying that “China should stick to its proactive fiscal policy and moderately easy monetary policy to fuel the economic growth as the foundation for recovery is not solid yet.” I was not at the conference, so I wonder if professor Li’s comments were spun a little, because according to the Xinhua article he also said that “the current economic advance was pushed by investment, which was not the final demand – stable economic recovery should be sustained by increased consumption,” and warned that Chinese banks should “improve credit quality and structure.”
So for all the rising skepticism among policymakers and scholars I think there is little doubt that we are going to see still more fiscal stimulus along the lines we have already seen. If there is indeed global excess capacity, as Justin Lin says there is, I cannot see how an investment-driven program to increase capacity, and one which is almost certain to involve a huge additional misallocation of capital (after all, 8% growth given the sheer size of the fiscal and banking stimulus is actually a disappointingly low level of growth), can be much more than a short-term stop gap. On the contrary, I think it will make the medium term adjustment even more difficult.
On that note I want to recommend Victor Shih’s excellent OpEd piece in the Wall Street Journal – Asia yesterday. He argues that:
Should this pace of credit expansion continue for the remainder of the year, China may well face a difficult trade-off down the road. The economy is unlikely to face a financial crisis because most of the debt is owed to domestic investors and depositors and China can still prevent large-scale capital flight. However, if inflation spikes next year, the central government will have to choose between shutting off credit, which will reveal a massive nonperforming loan problem currently obscured by a torrent of new loans, or an unprecedented level of inflation. High inflation is destabilizing, as it has caused major runs on the banks before. If additional credit expansion in the face of rising inflation is not an option, the greater the extent to which lending is uncontrolled at the moment, the bigger a nonperforming loan problem the central government will face in the future.
An often overlooked ingredient to China’s success story is that generations of top-level central technocrats like Chen Yun, Yao Yilin and Zhu Rongji time and again used their political influence to constrain local investment bubbles, thus forestalling high inflation and major financial crises. Past retrenchment campaigns were unpopular and controversial, but senior technocrats nonetheless maneuvered to stop uncontrolled local investment. As credit continues to rocket toward the stratosphere, China is in increasing need of such leadership again.
Before closing this long post I want to add three additional comments. The first involves a conversation I had with one of my Tsinghua students who graduated in 2003 and now works as a currency trader. Last year he bought a few apartments in Chengdu, the capital of Sichuan, his home province, for speculative purposes, and in spite of surging land prices he seemed to think it was a terrible trade.
I asked him why, and he said that although real estate prices had gone up dramatically since he bought the apartments, and he needed the money back, he nonetheless found himself unable to sell the apartments. That’s a little weird, I thought. Rising prices should mean eager buyers, but he can’t get anyone to take the apartments off him?
Has any other of my blog readers experienced anything similar? Of course the historian in me remembers that during the final two years of the Japanese bubble, when land prices soared to levels never before seen in history, there were complaints by sellers that transaction volume was so thin that they couldn’t actually sell their land.
My second comment concerns university unemployment. I have been writing for three years that unemployment among college graduates in China was soaring, and that authorities were understandably nervous. So nervous, it seems, that they have been putting pressure on university to do more to get jobs for their graduates by limiting their next-year enrollment to the number of graduates this year with jobs.
There are, of course, two ways to improve statistics. One way is to improve the underlying reality. The second way is just to fake the numbers. According to a Tuesday article in the People’s Daily:
I had no idea that I already had a job,” the student, who had been hunting for work, wrote anonymously on a website. In order to ensure a high employment rate and deliver a satisfactory work report during the global financial crisis, some Chinese universities have been faking work contracts or employment agreement for graduates, Southern Metropolis Daily reported yesterday.
This kind of thing will mean that the college employment numbers, a very useful figure for understanding the effect of economic growth in China, are now much less useful. Already the People’s Daily article cites differences between the Ministry of Education numbers and a private firm’s numbers.
The Ministry of Education said that nearly two thirds of them [2009 college graduates] had already secured jobs before graduation in early July. But this figure differs widely with an employment report from an independent consulting firm on higher education. A report from MyCOS HR Digital Information Co said 58 percent of prospective graduates had not signed job contracts by the end of June and that 2 percent had contracts cancelled.
By the way the article has an interesting graph on the number of college graduates over the past eight years, for those who are interested. The total number of university graduates has surged from 1.45 million in 2002 to 5.59 million in 2008 and 6.10 million this year. The intervening years saw 2.12, 2.80, 3.38, 4.13, and 4.95 million graduates.
My third comment is about the great article in today’s Wall Street Journal on the explosive development of the Beijing music scene, a subject that all my friends know is one dear to my heart. Anyone who is interested in knowing more about this scene should read it.
[...] Economists need a holiday July 23, 2009 The economic crisis is steep, worsening. Green shoots this spring proved elusive. Except in China, for which a generally pessimistic IMF forecasts 7.5% growth this year, where the stimulus package, tough government intervention, and probably some data massaging provide for more growth than elsewhere. Some at Goldman Sachs believe even that China is going to pull us out of the recession – if one believes the message brought to Brussels last week. I am sceptical, as it appears – read here and here – that the Chinese government tends to persist in its past mistakes: the current mini-boom might well be short-lived. And are the Chinese rich enough yet to pull and the US Americans, and the Europeans, let alone all the others, out of their rut? [EDIT 24 July: Michael Pettis blogs about all these issues! Have a look.] [...]
Wow! Thanks for a great post! I had read most of the articles, (aside from Victor Shih’s one) but it is very useful to have them all linked up so effectively.
Also, I think it is nice to see opinions and quotes from officials rather than Sell-side Investment Bank analysts. So this collection is a real treasure trove.
Prof Pettis. Today BNP estimated that 11 Trillion RMB could be the total lending for this year. Do you have any further thoughts about when the brakes will be put on this year – or perhaps next?
On that topic, here is an excerpt from an article (sorry i have forgotten where i clipped it from – Caijing probably) about ICBC and their lending policy:
I haven’t looked at other banks half year new lending stats yet. I was wondering do you have any idea for the first half of lending divided between Big 4 (or 5), CDB, AgDB,local banks etc? I am wondering where the remaining 6 months’ lending will come from…
ICBC article excerpt
”
8. ICBC to Cap Lending in Second Half of 2009
The Industrial and Commercial Bank of China will severely curtail new lending in the second half of 2009, a senior ICBC official told Caijing, amid mounting fears about bad loans and inflationary pressures arising from China’s early-year loan surge.
The world’s largest commercial bank by assets will cap new loans for 2009 at around one trillion yuan, the official told Caijing, adding that meeting the target will not be easy. ICBC extended 824.2 billion yuan worth of new loans in the first half, and the full-year target suggests it will grant loans of only 175.8 billion for the remainder of 2009.///”
“…although real estate prices had gone up dramatically since he bought the apartments, and he needed the money back, he nonetheless found himself unable to sell the apartments.”
Perhaps the Chinese market is similar to that in Thailand, with which I am more familiar – married into a Chinese Thai family. My understanding is that there is very little resale of residential property in Thailand, as no one who can afford to buy – i.e., the middle class – wants to live in someone else’s old house/apartment. Besides, there is always a new development competing for the purchase. The marketing of new condo developments involves small monthly payments that are to reach 20% of the total sales price at completion and possession – something that lends itself to speculation among those who hope to flip before having to finance the entire purchase. When times are booming, they can indeed flip during that pre-possession period. But once owned, the onus is to find renters and manage the property. That results in a lot of empty condo towers that suck mortgage payments out of erstwhile speculators, a great way to dampen consumer demand for an extended period after a boom. If credit flows stop, many if not most of the speculators never close on the property, and you end up with an unfinished project. It’s like the underwater U.S. homeowner on steroids for much of the middle class. (Even though similarly vulnerable, at least the stock market is liquid!) When the music stops in China, I suspect you will see similar effects. Certainly your former student’s disposable income is much smaller than he would have without the apartments.
Dear Micheal,
I believe you over-estimate the problems that short-term over-capacity will bring to China.
With double digit growth in demand of nearly every commodity as well as energy over the past years and presumably well into the future, even a 100% excess capacity will be absorbed in a few short years.
Also, I believe the Chinese government is not at all worried about non-performing loans. Only a few years ago the government spend 200 billion dollars to clean up the bank’s balance sheets. And they have no compunction about doing it again. That problem is 3-5 years in the future. Nothing to worry about right now.
I believe that given the global climate, the government had no choice and this is probably the lesser of two evils.
[...] With the export sector completely imploding in the past year (down 25%), economic expansion in China has been driven almost entirely by investment. And while GDP growth this year will likely reach the magical 8% that the government is looking for, a lot of economists are worried about long term problems due to excess money supply, non-performing loans and excess capacity. A good summary of the issue can be found on the China Financial Times blog here. [...]
[...] Excerpt from: More public worrying about the Chinese stimulus [...]
Well, Wen is criticized for not being tough enough to prevent the overheat in economy(especially in real estate) in 2005. That is partially the reason why there was huge inflation in 2008. Again, this time many people do not have confidence on him to be tough again.
Off topic: where do your assistant go? Last time I saw him in your bar on Xmas Eve, he seemed to be a little bit worried.
Two aspects of the situation in China are echos of what happened in the U.S. during the last few years. First, easy access to new loans keeps default rates low at the top of the bubble. This story dates from when transactions were peaking, about 8-9 months before prices peaked:
“Late mortgages in California fall to historic low”
San Francisco Chronicle
Wednesday, June 22, 2005
http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2005/06/22/BUG48DCEHO1.DTL
Second, as Michael’s student has experienced, prices are sticky and don’t begin to fall precipitously until well after sales have.
Here are two recent posts from Calculated risk with excellent historic graphs. The first shows how sales volume peaked in the summer of 2005, then fell causing inventories to surge.
http://www.calculatedriskblog.com/2009/07/existing-home-sales-increase-in-june.html
The second show the Case-Shiller index. You can see it peaked in the first half of 2006, and didn’t begin a precipitous fall until late 2007.
http://www.calculatedriskblog.com/2009/06/case-shiller-house-prices-fall-in-april.html
During 2006-2007, most commentators did not see the collapse of a bubble, just a “healthy correction.”
[...] This post was Twitted by da52543 [...]
[...] More public worrying about the Chinese stimulus (Pettis) [...]
Victor Shi warning about high inflation next year? lol
in the words of Wu Xiaoling quoted in this article itself:”
Under conditions of overcapacity, excess money supply will not lead to rises in price indexes”
Asset bubble is a legitimate concern, but easy to solve with blunt regulatory tools that the Chinese government always have
Hi, I’m a Analist at a Investiment Fund in Brazil and read your blog very frequently. I find it very helpful to learn/listen about china directly and for that I´m very thankful to you and you and your blog. This was a great post and it’s incredible how so many people ignore this “fake” side of china’s recovery. Thanks
thank you for this compilation and analysis
Great info, perspectives and columns, thanks
“Production Line To Picket Line – China”
http://www.youtube.com/watch?...
In one part of the film a college graduate is looking for work and he’s scouring a job post bulletin board. He has to pay 200 yuan if he wants to apply for one of the listings. The only problem is that the job posting could be fake and he won’t get his money back.
How disheartening is that?
Interesting analysis here:
China: Bogus Boom?
By John H. Makin
AEI Online
Saturday, August 1, 2009
http://www.aei.org/docLib/08-EO-Aug-2009g.pdf
Anyone have any knowledge on the ETF FXI? I’m thinking mid September would be a good time to buy.
Actually FXP. Mid September?
You seem to artificially separate productive consumption from unproductive consumption. Productive consumption is still consumption. Investment in housing, railways, roads, ports, dams, hydro schemes etc. consumes enormous amounts as is demonstrated unequivocably by the quantities of raw materials being imported into China right now (and yes I know about stock building etc.etc.etc). While having the contingent benefit of developing infrastructure, increasing the urban population, broadening the market etc.
Pardoxically if the Chinese authorities were to follow your recipe, raising wages, cutting investment, reducing loans and tightening lending standards, they would hit profits, lessen demand, and create an almight crash. Your policy proposals would lead straight to crisis.
Biil J, as I have said many, many, many times, the idea that China must choose between a policy that leads to trouble and a policy that leads to happiness is a myth. China must choose between bad and worse, and the trade off, I suspect, is between a short term rise in unemployment or a long term slowdown in growth.
I supect they will choose the latter, and there may be good reasons concerning social stability for doing so, but it is not necessarily the least costly choice in economic terms. In fact if Chinese fiscal and monetary policies are not coordinated with those of the US, with an explicit commitment by the US to keep borrowing to slow down its demand contraction, or if there is a collapse in trade, the latter might not only be more constly in the long term, but it might also be more socially disruptive.
I plan to discuss this more fully in my next entry, on what I hope (but doubt) will come out of the SED.
Michael.
Re Chengdu: I have been following this market for a few years, and it is one of the more interesting to me as it is so different than Beijing’s and Shanghai’s
LEaving aside the massive run up in prcing that it experienced (and how that compares to SH and BJ), this is a market that NEVER made sense as a landlord. Properties were often unable to maintain leases that would cover mortgages, and as such attracting new buyers into the 2nd hand market were limited.
It is a condition made more difficult as, unlike Shanghai and Beijing, you do not have the foreign traffic to support rentals. Domestic managers moving to the area were buying their own properties rather than renting, and that contributed to the softeness
At the same time, the pool of quality assets is small. 5 years ago when planning a portfolio transaction for one investor, we quickly realized that had we executed the purchases we would have cause inflation in the market. that the supply limitations often exaggerate the demand influence on pricing.
Finally, the buildings in Chengdu age fast. faster than Beijing or Shanghai, and so many buyers are looking only to invest in new properties.. or in property rights for buildings not built yet. The conditions are improving as Shui On and Hutch build in the market, but Chengdu still has a lot of regional developers who are using regionally accepted standards.
for more, check out my posts Chengdu is building.. and building.. and building, Chengdu: If you built it… they will come and If You Build It, They Will Come (Part II)
r
http://www.allroadsleadtochina.com
Bob in MA makes a valuable point a slow down in sales volume often precedes the fall in prices by a couple of quarters at least. Prices are sticky in the US in part because of the nominal contract loan balance. A 10% fall in prices would, of course, be 50% hair cut for someone starting with a 20% equity position. And that makes lowering prices a tough pill.
With the long term lease position of Chinese real estate, I don’t precisely how that would play out there. How are residential real estate purchases usually financed in China, and is this being goosed also, or just on the developer’s end?
I always feel depressed after reading Prof Pettis’s words.
Looking into the detail of stimulus package,the lion share goes to construction of railway,highway and airports(1.5tri out of 4 tri).It’s directed at a bottleneck transportation problem,not an overcapacity problem.I guess you would never criticize China for being over-modernization,right?
Even if some loans go sour later,it would not be the global shareholders bearing Chinese banks’ cost.It’s the governments.So if you worry about NPL ratio,you would better worry about government solvency,especially local governments,and seriously county governments and town governments. How this story is going to unravel I really don’t know.
Your student’s houses won’t be a easy sell.In 2006,central tax authority has levied a 20% sales tax on second-hand home transaction which lowers the appetite for second-hand homes against new homes.Chengdu is in the 08 quake zone so I think the buyers will be a bit jittery even now.He or she may rent them out first and wait.
Record stimulus was needed because of record capital outflows and a dramatic decline in exports. As Brad Sester just blogged “China’s stimulus has worked.”
Now, with investment capital flowing back into China, stimulus spending can ease off somewhat. That’s how it’s supposed to go. It’s just the rest of the world that can’t seem to get it right.
Long term problems? Sure, potentially. Short term China has a whole lot of flexibility and is still making good moves (like the recent solar subsidies) that boost investment now to position itself to be even more competitive in the future.
http://www.frontlinethoughts.com/pdf/mwo072409.pdf
Some interesting stuff about Copper in this report from John Maudlin
and
Article from FP maagzine about China’s economic future. A super-bear!
http://www.foreignpolicy.com/articles/2009/07/23/the_china_bubbles_coming_but_not_the_one_you_think
On these fake work contracts, i have friends at schools here in Beijing who are blogging about the same thing. I think this is a very widespread practice.
[...] students at Tsinghua or Beida had any interest in what we would call countercultural stuff," says Michael Pettis, a finance professor at Beida’s — that is, Peking University’s — Guanghua [...]
On the graduate unemployment question, this is one that the NDRC has also focussed on. As growth rates rose in China during the past few years, rates of job creation slowed. This is why I have been asking for the stimulus package to “show me the jobs”. China has a high growth-rising unemployment problem. Second, the government has admitted that it has virtually no statistics on 150-200 million migrant workers. Astounding! How can we judge the state of the economy without knowing what is happening with a workforce the size of that in the US and EU, combined? This is all sounds pretty depressing, but I think that we need to consider China’s parallel economy, the one outside of the statistical system and all of these interesting debates. This gets back to social lending and entrepeneurial patterns that were there long before the revolution. A migrant worker loses his job, goes back to the farm and idles away. Some are content with this, others are not. The ones that are not borrow money from family members, and maybe even a local official, to engage in some sort of trading, maybe even a low-value industry that employs the worker and a few buddies. Some fail, but some make it through until overall conditions normalize and they think about moving back to the big city. There are others who stay in the big city, and use similar means to make a living. These kinds of patterns are a far better econonomic stabilizer than a stimulus plan, probably about half of which is sitting in personal bank accounts of officials who put the people, specifically their people, first. This is the case because it connects the economic and social dimensions in ways that the formal economy cannot because civil society is so underdeveloped, and the government has never lifted a finger (there has been plenty of jabbering) to support these people. This is really a parallel universe to the one that everyone debates, but is very important, I think.
Similar to yours, Houhui. But I guess this is more bearish — an uber-bear
http://www.philstockworld.com/2009/06/20/china-real-estate-story/
[...] Was geht in China ab? http://mpettis.com/2009/07/more-publ…ulus/#comments … My second comment concerns university unemployment. I have been writing for three years that [...]
Houhui,
The fake contract is not only a wide spread practice. It has been there for a long time, at least I first heard of it around the end of 1990s or the beginning of 2000.
MoneyIlluusionist,
If you don’t like to feel depressed by reading Pettis’s blog you should read Chinese newspapers. They are always very happy stories about the economy. It is easier to find the true here on this blog. Thank you Professor.
Most of the newspaper quotes in this post are from Chinese newspapers and they don’t sound very happy at all.
In the CBRC statistics announced recently on the improvement of domestic banks’ NPL ratios, did you notice that foreign funded banks went the other way? While domestic state owned banks NPLs fell 44 billion RMB, foreign banks NPLs in China increased by 10% to 6.7 billion for the same period.
This could be explained that foreign banks’ clientele tend to be SME’s or subs of MNC’s (which might be having trouble in their home countries). However, it could also be attributable to better credit monitoring and risk management by the foreign banks. Personally, I think its a combination of both.
There is no question that the Big Bang here in the first 6 months is going to have an impact on credit quality. Bankers don’t know what a downturn is like and since the PBOC creates a guaranteed spread between deposit and loan rates, it’s all about pushing out volume. Name lending is common and the large SOEs are such powerful issuers that due diligence is laughable. There is no syndication market per se in China because the state owned banks have huge checkbooks and the last thing they want to do is invite a co-investor/competitor to share in the deal. So the exposures are big, lumpy, and not well analyzed.
Also does anyone have China’s tax receipt information for the second quarter? Remember in February that tax receipts had fallen about 18% in the first 2 months of the year. If that has continued (even half that decrease), how does one explain the 6-7% GDP growth that is being reported? It could be the change in GDP mix away from exports. Could be some of the tax concessions implemented this year. Could be more cheating going on since much of the domestic economy is still cash based. Or it could be the growth numbers have been “managed”. I’d be interested in any comments on this and any referral to website with current tax receipt information.
Jeff – good points. My suspicion on the growth is that bank short term loans are funding working capital for loss making plants and enterprises (Chinalco, steel, other stuff I follow) plus some exporters. Problem is that there’s a good amount of anecdotal evidence that additional loans are going into real estate and equities. This bubble is getting very bad already, and judging by technicals in the equity markets its not going to stop anytime soon, making the adjustment all the more difficult. Where’s Zhu Rongji when you need him?
interesting question on taxes. For the month of June, the MOF reported that total revennues were up by 19.6%, with central taxes up by 15.9% and local taxes up by a whopping 23.5% y/y. This last figure is pretty unbelievable.
All in all for H1, total revenues were down by 2.4%, with VAT down 3%, enterprise income tax down 13.8%, personal income tax up by 0.7%,customs duties down by 30%, and revenues from the stamp tax down by a whopping 74.5%.
This would appear to point towards a rebound in certain areas of the economy, but not so much in the external sector. The -2.4% overall y/y decline for H1 does not seem to be too far from what one might expect given the net impact of cyclical tax collections, that is compared to H1 2008.
Jeff, I thinking watching forign banks for a reality check is a very smart move. It is certainly strange that foreign banks, who are expanding loans at a much more prudent rate, are reporting higher NPLs during these tough economic times, while Chinese banks, who are lending like there is no tomorrow, are reporting lower NPLs. This just doesn’t seem reasonable to me.
MSG, Pettis makes the point that he has culled these few “depressing” reports mainly from the very non-mainstream Caijing, and that these realities are packed in amidst very different stories. I agree with XuX that anyone who reads only Chinese newspapers would think that the crisis was largely limited to the West and had missed China altogether (thanks to the hard work of the leadership, of course).
There’s a little about total 1H09 tax receipts in this piece from Reuters y’day (by Simon Rabinovitch):
- QUOTE -
ERODING FINANCES
Government revenues declined 2.4 percent in the first half compared to a year earlier, well shy of the official goal of an 8 percent rise. Expenditures were ahead of target and set to surge in the second half on the back of
infrastructure projects.
Tax intakes are, of course, closely tied to economic activity, so China’s upturn should deliver cash to government coffers. But improvement in June came mainly from land sales, a one-off revenue source that masks the difficult road ahead.
For related graphic, double-click on:
http://graphics.thomsonreuters.com/079/CN_IMPRVNT0709.jpg
“Even when we are already factoring in relatively optimistic revenue growth due to the economic recovery, the deficit is quite sticky at around 5 percent per year for the next three years,” said Isaac Meng, economist at BNP Paribas in Beijing.
- END QUOTE -
This article also has a good discussion of the “hidden debt” often discussed here. It included the following which I found especially interesting – would be grateful for further color from those familiar with this type of financial engineering.
- QUOTE -
“DEBT BOMB”
Most troublesome of all is the potential for a “debt bomb”, in the words of China’s Economic Observer newspaper, at lower levels of government as officials engage in financial engineering that is both opaque and highly leveraged.
Rules prevent Chinese banks from lending to governments the equity capital which they need to obtain further loans for investment. But local officials and banks are now exploiting a vast loophole thanks to intermediaries known as
trust companies.
The process is simple enough. Trusts create specially designed “wealth products”, which banks sell to their clients. Banks then give the funds to the trusts and they, in turn, funnel them to governments as equity capital.
Local authorities, in short, are piling debt on top of debt. The Chinese banking regulator has started to warn trusts and banks of the growing risks, state media recently reported.
- END QUOTE -
Sounds a bit like the inclusion of AAA-rated securitized products in US/European bank capital, such that as banks made new loans, they simultaneously created the ‘capital’ required to support them. That’s worked out well.
Well at least we now have clear counter-positions of analysis and conclusions that can be factually tested.
Michael Pettis and Martin Wolf’s analysis of China’s ‘overinvesting/oversaving’ leads to the view that the stimulus package will fail – Stephen Roach arrives at the same conclusion for slightly different reasons.
In addition to positive evaluations of the stimulus package by Jim O’Neill and Danny Quah I have referred to in other comments, readers may be interested in one by the US economist Mark Weisbrot which appeared on the Guardian’s Comment is Free.
It is hardly surprising that commentators in China have similarly divergent opinions. While Michael Pettis quite justifiably points to views in China that are raising issues (some serious some only tactical) about the stimulus package there are evidently also a lot of people who support it – number one, of course, being the government which is implementing it as well as those cited in this post.
The individual examples produced in this post do not prove anything by themselves – I don’t think Michael Pettis would claim they did but it should be pointed out. As an average necessarily means that there are points below the average as well as points above it, it will always be possible to find examples of bad/very much below average investment decisions – which will be statistically balanced by above average (i.e. highly efficient) investment decisions. All the major Total Factor Productivity studies find that the average level of efficiency of China’s investment ranges from ‘respectable’ (Alwyn Young) to high – the studies by Jorgenson and Vu. This, evidently, does not prevent there being, within these averages, many examples of terrible investment decisions (and others that were excellent and far above average).
The same applies principle applies to the argument about Non-Performing Loans. If instructions are given to increase lending in conditions of an international economic downturn and financial crisis (as is the situation in China) it is evident that the proportion of bad loans is likely to (or more bluntly will certainly) go up. Therefore to increase lending while simultaneously increasing the provision for non-performing loans is a highly rational policy.
The issue is a quantitative one. If the macro-economic benefits of the high lending in terms of economic growth outweigh the negative impact of the non-performing loans then it is a good policy despite the increase in the number of bad loans – and incidentally that growth will more than finance the write off of the non-performing loans incurred. In short the criteria that must be targeted is the overall macro-economic situation and not an individual criteria such as minimising the number of bad loans. Therefore, believing that the stimulus package will basically work is not at all contradictory with recognising the number of bad loans is likely to go up – my guess would be that most people who support the stimulus package assume , as I do, that the number of non-performing loans will increase and therefore increased provision for them is highly sensible.
If, of course, the increase in the overall number of bad loans outweighs the macro-economic benefit then the stimulus package is a bad policy – that must be one argument by those who believe the package will fail.
What is good is that the divergent analyses are going to be tested by reality over the next few months to couple of years – which is as it should be. We won’t have to wait very long to find out which analysis is right.
Greetings to the pessimists who have contributed such interesting comments and warnings that the explosion in Chinese bank lending and the fiscal stimulus will peter out and perhaps end in tears.
While these arguments have merit, you might be right for the wrong reasons. The problem is that we know very little about “asset prices” and bubbles. Hence, while you make logical arguments to “proof” that certain asset prices (the stockmarket, housing prices, commodities) are out of kilter — these arguments really don’t matter.
Paraphrasing Keyne’s (badly) — the market is a beauty contest. You don’t vote for the girl YOU think is the most beautiful –but for the one you think the “MARKET” thinks is the winner.
Hence, current macro policy is a huge confidence trick akin to a Ponzi scheme — to keep asset prices afloat to avoid the curse of debt deflation. This means that current massive fiscal and monetary stimulus is a huge government “put” for asset prices. BUT to avoid actually “paying” — a whole set of safeguards are de rigeur, hence the lofty speeches about “exit strategies”, medium-term fiscal triggers, better regulation, raising capital requirements and fears about inflation.
Given that “expectations” and animal spirits are driven by fear and greed — the “trick” is to calm fear while stoking greed in periods of huge financial stress, by implicit “puts” in asset markets. All of the above “hand wringing” and fears about future NPLs and money flowing into speculative asset prices may be misplaced as they were actually designed to avoid instantaneous “Ricardian equivalence”.
In sum, I give an A to the the FED, FDIC and Treasury “puts” and an A+ to the Chinese for their expert “manipulation” of stockmarket and housing prices since early March. This has perhaps bought them time for the fundamentals to kick in. But, if they don’t — then it is back to the drawing boards or rather the printing press for another round of “puts”, regards James
TR,
I actually read a lot of mainstream more importantly local newspapers and it’s definitely not wonderland. Here in Chongqing it’s all about the property boom but there’s literally daily stories filled with people who can’t afford or are being evicted along with throngs of ‘bongbong’ army out of work. It’s actually pretty depressing especially since Chongqing has largely avoided the crisis until now.
John Ross
Another side to this is not just Non-performing Loans, but also the drain on profits that debt obligations will cause in the coming years. If the loans have been used for productive profit generating investment, then similarly to your point about NPLs, this is by definition a price worth paying. I think some (including the CBRC and increasingly the PBOC) are worried that this is not the case.
Again I feel that investors should be cautious about relying on sell-side analysts – who are often tactical too.
As an aside, i would like to link to an article by Huang Yasheng. India V China debate aside, he makes some interesting points about “quality of growth issues” particularly Personal income growth to GDP growth ratios, and how this, along with other less economic factors (health, literacy) may have been showing reversals in China at points during the reform period.
http://www.foreignpolicy.com/story/cms.php?story_id=4345&page=1
Here is the question / answer session associated with the above story.
http://www.foreignpolicy.com/story/cms.php?story_id=4362
Today I read a special Article at Asia Economic Institute about Beijing’s financial district website (www.asiaecon.org/special article) titled: “Beijing To Build New Financial District” that talked about Chinese government plans to expand Financial District in Beijing. China Development Bank Corp, Industrial & commercial Bank of China Ltd., Agricultural Bank and China Construction Bank Co. will provide $ 8.78 billion of loans. After that construction, Financial district in Beijing will be a new Asian Wallstreet.
[...] fact as I have argued many times (for example here, and here), I suspect that most of the Chinese fiscal stimulus is exacerbating the imbalances – [...]