There is an air of increased optimism in the global economy, and it is especially strong with relation to China. After all, China has no impending collision with a “debt ceiling” like the US, and is structurally still competitive unlike much of the European Union. China’s data is looking positive in the short term. Yet this newly initiated investment-led boost to growth is exacerbating China’s deep economic imbalances and may come back to haunt the country’s new leaders later in their tenure.
The simple facts are well known: China’s economy needs to rebalance away from investment and exports towards domestic consumption. For this to happen, consumption (driven mostly by household income) needs to increase at percentage rates higher than GDP growth for several years. Meanwhile investment must do the opposite – or else the debt that lies behind it is set to become an even greater risk for the economy as returns diminish. China is currently undergoing yet another mini-investment boom, with increased spending on real estate construction, infrastructure and especially railways as the government reacts to more than a year of slowing GDP rates. Since September, non-bank sources of financing, including trust lending through wealth management products, have been providing much of the new funds as these statistics show. Many worry that these opaque forms of financing are dramatically increasing risks in China’s financial system.
This “stepping on the accelerator” was widely expected by analysts watching China, who argued that the incoming leadership of Xi Jinping and Li Keqiang would not be comfortable starting off their tenure without halting the falling growth rates of recent periods. If they are to quickly consolidate their hold on power, growth has to pick up.
Reuters recently published an interesting piece of analysis arguing a similar line. Whilst China’s difficult economic rebalancing is almost certain to involve lower rates of growth, , Reuters here suggest that the economic slowdown must first be stopped before serious reforms can begin.
Michael Pettis, famous China finance expert and Professor at Beijing University, argued recently in a note that, counter-intuitively, if China’s growth rates remain high throughout 2013 (around 8%), this is a sign that leaders are not yet seriously attempting rebalancing, and thus the eventual cost of adjustment will be higher and more painful. He recommends watchers to focus on the second half GDP figures, stating:
“If Beijing has really gotten its arms around the rebalancing problem and is serious about adjusting quickly, I expect reported growth to drop sharply, perhaps to close to 6%. If not, I expect reported growth to remain well above 7% in the second half of 2013. This would worry me.”
Even with growth picking up, it would be unwise for investors to get too enthusiastic about China’s prospects. There is a strong probability that this pick-up is designed to be fairly short term, as China’s leaders have repeatedly stressed the need to rebalance. If the acceleration continues too long, it will only increase China’s already considerable credit risks whilst making the eventual and necessary adjustment all the more painful. Investors would be well advised to watch seriously for signs that policy is shifting again, and if not, to consider the longer term consequences of China’s increasingly shaky development model.