The aftershocks of the global credit crisis may have been felt most recently in Dubai, causing minor palpitations globally, but experts believe that a far bigger rumbler may be waiting to explode in faraway China, with far greater destructive force.
In particular, long-standing structural deficiencies in the Chinese economy are being accentuated by Chinese policymakers’ response to last year’s global economic crisis, and jeopardising economic recovery in China and around the world, they fear. “Overcapacity is a blight on China’s industrial landscape, affecting dozens of industries and wreaking far-reaching damage on the global economy in general, and China’s economic growth in particular,” notes a recent report from the European Union Chamber of Commerce in China in partnership with Roland Berger Strategy Consultants.
And although there’s nothing new about overcapacity in China, “its pervasive influence has become ever more prominent — and its effects on both the Chinese and international economies have become ever more destructive — in light of the global economic crisis that still grips world market,” it added.
Much of that “overcapacity” has been driven by an orgy of capital spending and the artificial peg of the Chinese renminbi to the US dollar to protect the export-led manufacturing industry.
But analysts at Pivot Capital Management warn that when it runs out, it heightens “the chances of a hard landing” in China.
“Given China’s importance to the thesis that emerging markets will lead the world economy out of its slump, we believe the coming slowdown in China has the potential to be a similar watershed event for world markets as the reversal of the US subprime and housing boom,” they warn.
The key to the Chinese miracle has been its very high investment relative to its gross domestic product (GDP). All developing countries tend to overinvest for certain periods during their economic progress, but China’s investment spend (gross fixed capital formation to GDP ratio) has broken all record. Post-war Germany achieved a peak investment to GDP ratio of 27% in 1964; Japan’s peaked at 36% in 1973, and South Korea’s at 39% in 1991. But China’s economy is reporting a 50%-plus investment to GDP ratio. For every renminbi yuan it produces, half goes back as investment.
Not only that, the investment boom has lasted longer in China than anywhere else: before China, the longest any country has sustained an investment to GDP ratio of over 33% was nine years (Thailand and Singapore). China is now in its 12th year of investment-led growth.
Few economists believe this is sustainable, but there are optimists, too, who do not share this “sky-is-falling” outlook on China. “China is not facing an imminent collapse from a big investment bubble or a mountain of debt,” says UBS economist Tao Wang. “The truth about China’s growth and risks is not as dramatic as some pundits make it to be.”
Wang argues that when analysing the issue of “overinvestment and excess capacity” in some sectors, it’s important to bear in mind that China is going through “a phase of rapid industrialisation and capital accumulation, which started from a relatively low base and is still at a relatively early stage.” The high investment-GDP and capital-output ratios, she argues, “are specific to the current phase of China’s growth, which has been very manufacturing-intensive and, in particular, biased toward heavy-industries.”
But even she believes that unless “structural imbalances” in China’s economy are addressed through adjustments to macro policies, “we expect… non-performing loans to increase down the road, and asset bubbles and excess capacity problems to worsen.”
BNP Paribas economist Guy Longueville points out that “production overcapacity is less significant than had been feared in autumn 2008.” But, he reckons, “there is still a general latent problem of overcapacity… which can re-emerge in the future.”
“The triptych of latent corruption, excess credit and excess liquidity favours dangerous or criminal investment,” adds Longueville. “Waves of ‘sheep-like’ investment by Chinese companies as soon as a sector looks promising can saturate demand a few years later.”
Hong Ho-fung at the Indiana University has a more searing account of what China’s “mega-fiscal-stimulus” did. Many of the investments under the stimulus programme, he reckons, “are inefficient and generally unprofitable. If the turnaround of the export market does not come in time, the fiscal deficit, non-performing loans and the exacerbation of overcapacity will generate a deeper downturn in the medium term.”
Citing a Chinese economist, Hong says that China’s “mega-stimulus programme is like ‘drinking poison to quench a thirst’.”