China’s monumental economic woes

10 May

China’s economy is going through a rough period and there are signs of major troubles with key sectors such as property and finance. There’ve been a lot of dismal numbers, such as economic growth in the first quarter of this year having slipped to 7.4 percent, the lowest in 18 months. Yet it’s not numbers that’s worrying but fundamental problems with the economy.

Quartz.com has this article that likens the current problematic state of China’s economy with Japan’s two decades ago, right before Japan suffered a property crash, and consequently went into an economic decline and stagnation that it still hasn’t really recovered from over two decades later.

China’s leaders aren’t foolish, which is why this current leadership has been pushing the message of reform for a long time now. More reform is definitely needed, tough measures need to be taken (for instance letting sketchy companies go bankrupt rather than bail them out), and problems should be tackled rather than swept aside or allowed to continue (the Quartz.com article above talks about this).

The biggest problem is property, which is a major part of the nation’s economy, providing the majority of local government revenue and taking up the majority of bank lending. For a long time, there’s been talk of a property bubble and there’re fears it’s right around the corner. In the first quarter of this year (Jan-Mar), property sales are falling significantly, even in first-tier cities like Beijing, to the point that some developers are offering big discounts on new homes. The vice-chair of a major developer was caught making some dire remarks about this. There are too many homes and offices being built, with seemingly every single mainland city and town in a construction boom in the past decade, prices are sky-high, home sales are lagging, and developers are having problems with cash flow, especially as banks have tightened lending.

Problems with the property market lead to problems elsewhere, which brings us to shadow banking, which refers to non-bank lenders such as trusts, leasing companies and money-market funds, with even state-owned enterprises and shipbuilding companies getting into the act (see the article above). These companies often lend to smaller property developers and other companies that find it hard to get credit from banks. As regulators have focused more attention on shadow banking, the sector has evolved as well, which is not necessarily totally bad, but the issue is if the expansion is going too fast and too out of control.
On the other hand, this article tries to argue it’s not so bad since a shadow banking crash won’t affect real banks and that these banks can easily cover bad loans with their profits in the event of a shadow banking crisis. It’s a bit optimistic in my opinion, as the writers seem to assume the best and ignore serious ramifications, such as saying that if a shadow banking crisis occurs, this will benefit banks since savers will move money back to banks without considering that savers may not necessarily have their savings intact if shadow banking suffers a huge crisis, or playing down the effects on raw material exporting nations if Chinese imports drop (frankly the article’s arguments seem very flimsy).
More convincing is this article which says the failure of shadow banking is a ticking time bomb, and will be very bad. Shadow bank lending has been used to finance many projects and developments that are failing or going out of business, such as the $100 billion industrial project and eco-city featured in the piece that has been all but abandoned.

Meanwhile, overcapacity is a big problem in heavy industry, as sectors ranging from steel to cement to solar panels have too many companies that produce too much that can’t be sold or exported. The government has issued orders such as shutting down old and poorly performing plants (setting targets such as reducing steel production capacity by 27 million metric tons) and limiting the number of new plants.

China is still a place of great opportunity and potential in fields like e-commerce and tourism. But its economic problems are vast and deep, and overcoming these will be painful.

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