In 2014, China is going to have to do something it hasn’t done for a long time – generate growth from something other than fixed asset investment. Will it succeed? Well, the jury is still out.
Analysts are starkly divided on China’s 2014 prospects. Deutsche Bank is the most bullish, expecting GDP growth of 8.6%. As the only investment bank out of 55 surveyed by Bloomberg expecting growth below 7%, Societe Generale is the most bearish, (it expects 6.9%). Not surprisingly, the mean and median forecasts are both 7.5%, 2013’s target.
China has not officially set a GDP target for 2014, but it may do so at the Two Conferences in March. However, there are growing calls in China for top leaders to no longer set an official target but rather give guidance, an effort mainly designed to reduce the importance (in the eyes of officials) of generating GDP growth.
If there was any doubt that such a change in emphasis is needed, it was put to rest when authorities published the results of the most recent survey of local government debt. Data from the National Audit Office showed that local government liabilities rose to 17.9trn yuan by the end of June 2013, up from 15.9trn yuan at the end of 2012 and 10.7trn yuan at the end of 2010.
In general, the roughly 5trn yuan increase from 2010 to 2012 is not that concerning given China’s known preference for local government-led investment and the fact that local government borrowing as a share of total borrowing in the economy actually fell from an estimated 36% and 25% of total social financing in 2009 and 2010 to just 19% and 15% in 2011 and 2012. Rather, the concern is the 2trn yuan increase in debt in H1 2013, which represented a 62% increase from the average amount of new debt accumulated over the previous four half-year periods.
The ramp up in debt was primarily facilitated by an expansion of so-called shadow banking, with sources of borrowing other than bank loans and bonds rising from 10% of debt in 2010 to 31% in H1 2013.
In particular, banks used complex financial transactions to transfer money invested in wealth management products (WMPs) to other entities such as trust companies that then lent these funds to local government units at high yields. The liquidity squeezes in June and December were one side effect of this practice as banks could not recover funds from trust loans to repay maturing WMPs, forcing them to turn to the interbank market to borrow money.
Although the debt survey was not released to the public until December, top authorities had certainly seen the results prior to the Third Plenum in November and Central Economic Work Conference (CEWC) in December, where top officials outlined China’s policy agenda for the next ten years and one year, respectively. It was the concern over local government debt that led to three significant policy announcements in December:
- The CEWC highlighted management of local government debt as a key priority for 2014, the first time local government debt risks have ever been mentioned at the annual policy meeting.
- The National Development and Reform Commission, China’s top economic planner, called for a reduction in government investment in competitive sectors, limiting it to projects such as social housing and related infrastructure, rural infrastructure, environmental protection and railways projects in central and western China.
- The State Council released its Document 107 demanding stricter regulation of shadow banking. The document called for a reduction of activities newly defined as shadow banking, including trust loans, some WMPs, financial leasing and certain bank credit guarantees.
The highlight of local government debt risks, restrictions on their investment and clampdown on their fundraising channels make it inevitable that China will see a slowdown in fixed asset investment (FAI) in 2014. Given China’s love of investment, Societe Generale’s 6.9% GDP target doesn’t look so much like an outlier any more.
In practice, the growth rate is unlikely to fall to those levels as Premier Li Keqiang in November set a floor on growth at 7.2%, the level he claims China needs to ensure full employment. Without government-led FAI as a driver, it is easy to imagine growth quickly decelerating to this level, however. China’s latest GDP figures showed that although GDP growth rebounded to 7.8% in Q3 2013, it was only achieved after a huge increase in FAI, which accounted for a five-year high 55.8% of GDP.
The big question, then, is how will China generate growth?
The answer, as bizarre as it may sound, is the private sector. The government began reducing the number of items that need government approval last year and will continue to cut red tape this year. Meanwhile, SOE reform is pushing ahead, with four major economic hubs, Shanghai, Guangzhou, Chongqing and Tianjin, outlining plans to reform SOEs, make them more efficient and increase private ownership of assets. It is hoped that the reduction of government control and deregulation will drive private investment in both underdeveloped and formerly state-led sectors.
Any view on whether or not this will work is pure speculation. The only thing that has always been a certainty in China, government-led investment, is now uncertain. So, can new growth points emerge driven by an entrepreneurial private sector and can the government refrain from interfering and resorting to its old tricks? Hold on to your hats folks, it’s going to be quite a ride.
Source: Forbes Business