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. 

Tags: Steundent employment, Victor Shih

There is some good news about Chinese retail sales, although I am not sure how useful it is because retail sales numbers in China have always been a little hard to reconcile with other indicators of domestic demand. According to an article in today’s Bloomberg:

Retail sales in China rose 13 percent during the three-day New Year holiday from a year earlier as both rural and urban consumers spent more, state television reported, citing commerce ministry data. Retail sales were 12.5 billion yuan ($1.83 billion) in the first three days of the year, China Central Television reported, citing a ministry survey of 1,000 major retailers. Household appliances and cars topped the list of purchases, CCTV said.

Against this, two recent indices indicate that manufacturing output continues to fare badly. The CLSA China PMI, released Friday, was 41.2 in December, the second worst month since the index started in 2004 (November clocked in at 40.9), and the fifth month in a row that in comes in below 50, which indicates a contraction in manufacturing output. The PMI produced jointly by the China Federation of Logistics and Purchasing and the National Bureau of Statistics was released today and, coincidentally, also came in at 41.2. According to an article in today’s Xinhua:

The Purchasing Managers’ Index (PMI) of China’s manufacturing sector climbed 2.4 percentage points month-on-month to 41.2 percent in December, China Federation of Logistics and Purchasing (CFLP) told Xinhua Sunday.

The index has been lower than 50 percent for three consecutive months. It was also the fifth time the index remained below 50 percent within last year after it fell to a record low of 38.8 percent in November. The new monthly figure reflected the country’s economy had further contracted, analysts said.

The article then goes on to quote Zhang Liqun, a researcher with the Development Research Center of the State Council, as saying that “the PMI figure indicated the economy remained in the tank but the number of purchasing managers who were bullish on the economy was on the rise. He said with previous macro-management policies taking effect, the economy would embark on a relatively fast growth track after the spring next year,” although the news agency regularly tries to put a positive spin on bad economic news, so perhaps we shouldn’t take Mr. Zhang’s comments too seriously.

The contraction may not be as bad as it seems because some of it seems to represent the running down of overstocked inventories, and so output could rebound in one or two quarters as inventories decline to the minimum necessary levels. Still, according to the CLSA report “Chinese manufacturers reduced the size of their workforces at the fastest rate recorded by the series to date.” An employment index it created suggests that in December we completed the fifth month of net layoffs, and of course rising unemployment is likely to lead to further contractions in demand. The risk is that we get caught in a spiral in which output declines to meet lower demand, but firing workers further forces demand to decline further. Unless there is a sudden rebound in export orders (don’t hold your breath) it will be up to new government spending to absorb unemployment and prevent demand from contracting further.

On that note Xinhua yesterday published a less upbeat story:

Cai Fang, a renowned labor expert in China, warns the country may see more job losses among urban workers in 2009 after millions of migrant workers became unemployed last year. The majority of job losses in 2008 were mainly reported among migrant workers, Cai, head of the Population and Labor Economy Institute under the Chinese Academy of Social Science (CASS), wrote in an article published in Caijing Magazine in December.

Migrant workers, who often work in factories, are among the first to bear the brunt of the current global financial crisis. Statistics from the Ministry of Human Resources and Social Security showed 10 million of China’s total 130 million migrant workers went back to their rural hometowns jobless last year after some exporters were forced to shut down or halt production to avoid losses as a result of decreased overseas demand. As a result, the income of rural and urban residents could grow at a slower pace, Cai said. The deceleration of income growth would definitely hurt consumption, he added.

There is a lot of hope being placed on either a revival of the export environment in early mid-2009 or on the success of the government fiscal expansion. The fiscal expansion plan is still too fuzzy to inspire much confidence and a number of Chinese economists I have spoken with recently are openly disparaging – even in print and on TV. One of them told me that he was worried that the government would be so desperate to boost growth that he wondered if we might not find ourselves having to choose between allowing growth to decline more sharply than anyone is comfortable with, or pulling out all the stops to jam growth forward, but in so doing create so much unsustainable and un-repayable debt that both the government and the banking system find themselves in real straits in two or three years.

Since this is something I also have been writing about, needless to say I agreed with him that there is a real risk that we “solve” the current problem by creating a more-difficult-to-solve debt problem in a few years. This is in line with my longstanding contention that there is no policy solution to this problem if by “solution” we mean some way of avoiding the consequences of massive overcapacity. It is just going to have to run down one way or the other, and without serious international cooperation the real policy choices for China are between “bad” outcomes and “worse” outcomes.

Actually quite a few local economists have been talking about the explosion in bad lending that they are expecting, and – no local economist, since he is American, but someone with a great view on Chinese policymaking – Victor Shih at Northwestern had a Wall Street Journal Asia Op Ed a few days ago which got a lot of attention and discusses exactly this problem. He says:

Risk-prevention institutions built up over the past decade are now under enormous pressure to forgo prudence in the interest of maintaining economic growth.…Meanwhile, if the economy worsens in the first quarter the government may be tempted to abandon prudent regulation altogether. Beijing could order the CBRC to disregard risk targets or even abolish the CBRC. This would plunge China back into the old days when the only risks that bankers faced were political ones.

I confess this is the thing that worried me most about the fiscal expansion plans. Since the social and political stakes are higher in China than in many other places, I think there is too great a risk that we overreact to the current mess by creating a potential debt disaster. This means that the next two years might not be as bad as I am expecting, but they will be followed by an even greater problem – another banking crisis – and without the furious global growth and ample liquidity of recent years, it will be much harder for China to grow its way out of a repeat of the late 1990s banking crisis.

I am struck in my conversation with Chinese economists about how openly dismissive they often are of recent policymaking. This adds some substance to the claims by my more politics-savvy friends that the debate – I hesitate to say warfare – within policy circles is hotter than ever. Blame, apparently, is flying back and forth, and even leaders at the highest level are facing strident criticism. This isn’t bad for China, of course, since one of the problems here has been the difficulty of changing policy once it has been decided, and a more intense debate should lead to a more realistic understanding of the consequences. It does suggest however how nervous people are.

One last comment before closing – I mentioned that there is still some hope in many quarters that there will be a revival in exports that may help pull China out of the current mess – even to the extent of people feverishly citing the explosive growth in Sino-Indian trade as an indication of things to come (although funnily enough Sino-Indian trade is almost negligible). I suspect that only people who have the dimmest understanding of the global environment and no sense of how the global balance of payments works hold this view (which is not to suggest that they aren’t the overwhelming majority), but it is probably reflected in the continuing debate about what must be done for China to regain its “competitiveness.”

In that light I though I would quote from an interesting article I read published by The Economist a scant few weeks (November 23) after the stock market crash of 1929. Perversely enough I love reading old article on economics and business news, and The Economist is a great source. This one says:

In any case, against any disadvantage arising from American competition must be set the great advantage which we mentioned at the outset, namely, the return to cheap money conditions. This should assist trade recovery throughout the world, which has been handicapped for so many months past by the abnormal financial conditions in New York. If we are justified in assuming that the setback in American industry will only be temporary, we may look forward to steady development in 1930, free from the incubus that has of late been hampering world conditions.

Tags: PMI, Victor Shih

After trading up four days in a row, with the SSE Composite closing on Monday at 2091, up 3.6% for the day, the market turned today and the SSE Composite lost 2.5% to close at 2038, less than one point off its intra-day bottom. What drove the four good days was continued talk of government intervention to support the market by buying shares.

What probably caused it to decline today was surprising comments made earlier by Fan Gang, an advisor to the PBoC, about a potential decline in exports in November. Actually the comments were not completely a surprise. Last Wednesday I mentioned in my blog entry that there were rumors swirling around the market that year-on-year exports for November had actually contracted by 7%. I was not able to get any confirmation, but it should not be a total surprise if that happened since Korean exports contracted year-on-year in November by 18%, and Taiwanese exports also contracted, by 23% (both were hugely up as recently as August). Here is what Bloomberg said in its article today on Fan Gang’s comments:

China’s exports shrank last month and industrial-production growth cooled, Fan Gang, an adviser to the People’s Bank of China, said today. “Things are not so good,” Fan said at a forum in Beijing. “November figures will come out soon, and industrial growth will be something around 5 percent and export growth will be negative.”

A collapse from October’s 19.2 percent export growth would add pressure on policy makers meeting in Beijing this week to do more to sustain the expansion of the world’s fourth-biggest economy. The government has already unveiled a 4 trillion yuan ($582 billion) stimulus package and cut interest rates by the most in 11 years as a global recession cuts demand for the nation’s toys, textiles and electronics.

To give a sense of how shocking an actual contraction in exports would be, two hours ago I met with a group of very knowledgeable China-research economists. I told them about the rumors of a contraction and asked for their opinion, and they said that although they definitely expected export growth to continue slowing, they would be really surprised and worried if it actually were negative. A contraction in exports year on year will suggest that the impact of the global slowdown on China is happening far more quickly than anyone expected.

My simple global balance of payments model should suggest, however, that we should have expected a rapid slowdown. After all if Chinese overproduction is the flip side of US overconsumption, and each requires the other, then the astonishing rate at which consumption is contracting in the US should have, as its counterpart, an equally rapid contraction of production or, failing that, a rapid buildup of inventory. Either of these will come as a result of declining sales. There is no point trying to predict Chinese economic numbers independently from US economic numbers. The world imbalance has been built around US overconsumption and Chinese overproduction, and one cannot change with a corresponding change in the other.

Whatever the actual trade numbers turn out to be, I suspect they are a hot topic in the Central Economic Work Conference, which started yesterday. This conference is held every year to discuss what happened during the year and to set the economic strategy for the coming year. Here is Xinhua’s take:

China’s annual Central Economic Work Conference opened here Monday to set tone for the economic development next year. Observers believed the three-day event would give priority to efforts to maintain stable economic growth.

They reckoned in 2009, China would see more risks for worse economic slowdown, more struggling smaller businesses, grim export situation and arduous task of transformation of economic growth pattern. “It is imperative for China to maintain an economic growth of at least 8 percent,” said Zhuang Jian, senior economist with Asian Development Bank’s China Resident Mission.

It was hard for China to bear the consequences of a too slow GDP growth, Zhuang added, citing bankruptcy of numerous enterprises, more migrant workers being laid off and difficulties for college graduates to find jobs.

Later in the article there is a discussion of some of the relevant issues facing the participants at the conference:

China has launched a scheme to subsidize rural residents for buying home appliances since the end of 2007. It is estimated that in a period of four years, nearly 480 million units of refrigerators, washing machines, color TV sets and cell phones, which were in huge demand among farmers, will be sold in rural areas nationwide. That means 920 billion yuan to be spent by rural consumers. “There is still a large room for the government to mull more policies to boost consumption, such as raising the threshold for taxable income and increasing income for lower-income earners,’ said Cai Zhizhou, an economist with the prestigious Peking University.

Export has since long been a major driving force for the Chinese economy. Economists believed the stable development of smaller enterprises, particularly the exporters, which provided jobs for 75 percent of urban employees and rural migrant workers, was related to the stability of the enormous Chinese labor market. How to prevent export from sliding down too fast is one of the top concerns of the Chinese government.

“It is no doubt that China’s export situation will become more grim next year. However, if the country manages to maintain a moderately fast growth in foreign sales of machines and electronics, it will likely achieve a growth of more than 15 percent in export at large,” said Mei Xinyu, a trade expert with the Ministry of Commerce.

China has taken a string of measures to boost development of smaller enterprises. “It is necessary for the government to work out more detailed, effective methods to mitigate tax burdens and enhance credit support for smaller businesses, and to help them with their efforts to promote technical upgrading and explore more markets,” said Zhao Yumin, another economist with the Ministry of Commerce. ]

Basically, and not surprisingly, everything is on the table for discussion. The more sophisticated of the commentators, like Cai Zhizhou, are focusing on demand management as the key to resolving the problem. Unfortunately a lot of policy-makers also seem to be focusing on boosting exports, or at least maintaining their level. The trade expert with the Ministry of Commerce, for example, is talking about boosting exports by 15% next year. This is fine only as long as it comes along with a much more sizable boost in imports, but somehow I don’t think the Ministry of Commerce is very worried in boosting imports. But like it or not the trade surplus must come down sharply, or it will indicate that China is still counting on its ability to export overcapacity onto the rest of the world, where there is too much capacity and not enough demand.

On a separate note, one of the blogs I read regularly to impress people with my insider knowledge of Chinese policy-making (I just plagiarize him) is Victor Shih’s blog on Elite Chinese Politics and Political Economy. Here is a recent entry, which suggest to me that my long-running contention – that the government’s fiscal position is going to prove a lot less solid than everyone has always assumed – is not implausible:

More details have emerged about the 4 trillion stimulus package that China has rolled out. The main questions remain: who will get the money? How will it be spent? In a revealing article published the 21st Century Economic Herald (my favorite), reporter Wu Hongying gives a detailed account of how Chongqing (a provincial unit controlled by princeling Bo Xilai) plans to spend the money. I believe the situation faced by Chongqing is similar to that in many Chinese cities and provinces.

Basically, Chongqing SOEs, which focus on land holding, real estate, electricity, and financial services, are in deep trouble. Land prices in Chongqing have fallen by over 70%. The electricity group is in the red by about 250 million RMB. The debt asset ratio for the 8 major SOE groups in Chongqing has risen to 72%. No details are given about the financial holding companies, but considering that their main role is to inject capital in the other SOEs, they can’t be doing too well either. Things are not pretty, and the well off SOEs have to inject capital in the problematic ones.

So, the central government rolls out a 4 trillion stimulus package. As I pointed out in the last note, only a part of the money will be from the central government, but at this point, local governments are desperate to get this part. Thus, a massive fraud whose working and purpose are perfectly clear to all the players involved is perpetrated. Basically, local governments propose projects which may or may not be implemented with the sole purpose of receiving central funding and “supplementary” (peitao) bank loans from the state banks in order to stave off the bankruptcy of local SOE groups, which are heavily indebted at this point.

The local “self raised” part of the capital can be a piece of idle land or a redundant factory. The excuses are many, but both the local and the central governments know that the center and the banking system must give a large chunk of money in order to prevent (delay?) massive bankruptcies of local and a few central SOEs. As for Chongqing, it has applied for 20 billion in investment before the end of 2008 (out of the 100 billion announced by the NDRC for China as a whole). Almost all of the money will go toward large SOEs in Chongqing. Due to Bo’s political connections, Chongqing will probably get at least 5-10 billion, thus staying solvent for some time

Tags: Export, Fan Gang, Victor Shih