China has been able to sustain a GDP growth of over 9% even in the midst of the worst financials crisis witnessed in decades. At the same time, there are many debates doing rounds on hard or soft landing for China.
This article looks into the current growth drivers for the Chinese economy and if the growth is sustainable in the long-term.
When I look at China's GDP growth and loans growth, the first very noticeable thing is the following -
From the year 2000 to 2008, the average GDP growth for China was 10.4%. During the same period, 20.3 trillion yuan of new loans were issued. In terms of GDP by value, China's GDP grew by 21.5 trillion yuan from 2000 to 2008 (from 9.92 trillion yuan in 2000 to 31.4 trillion yuan in 2008). Therefore, one yuan of new loan lead to an incremental GDP growth of 1.05 yuan during the period under discussion.
For the next three years (2009-11), the average GDP growth in China was 9.6%. During the same period, 25.74 trillion yuan of new loans were issued. In terms of GDP by value, China's GDP grew by 15.8 trillion yuan (from 31.4 trillion yuan at end of 2008 to 47.2 trillion yuan by 2011). Therefore, one yuan of new loan lead to an incremental GDP growth of just 0.61 yuan in the last three years.
New loans as a percent of GDP averaged 22% in the last three years compared to 13% during the period 2000-2008.
As evident from the above numbers, the GDP growth in China post the financial crisis has largely been fueled by record loans growth, which have been directed towards fixed asset investments and also to a certain degree towards speculation in asset classes (particularly real estate). According to the National Bureau of Statistics numbers, China's fixed investment growth (year-on-year) is still over 20%.
It is also evident from the above numbers that the impact of new loans on GDP growth has declined drastically in the last three years. This also raises questions over the employment of new loans in the right direction.
There are several questions here -
1) Is such a high level of growth in fixed asset investment sustainable?
2) Can easy lending standards lead to bad loans growth and speculation across several asset classes?
3) Will higher inflation (at some point of time) lead to tightening of policy and collapse of new loans growth, and hence, a meaningful slowdown in the economy?
The answer to the second question is already showing up in results of the banking system in China. According to Bloomberg news (from a report from China Banking Regulatory Commission) the non-performing loans rose by 20.1 billion yuan to 427 billion yuan as of December 31, 2011. Another very recent Bloomberg news release also talks about a significant rise expected in bad loans in China for 2012.
Clearly, the negative impact of record rise in new loans in the last three years will be seen in the banking sector in the foreseeable future. Further, it is a known and acknowledged fact that real estate speculation is running high in China.
Coming to the question of tightening policy, the year-on-year CPI growth for February 2012 for China was 3.2%. This has decreased significantly from 6.5% in July 2011. Therefore, the policymakers have the headroom to allow loans growth to sustain in the near-term. However, any renewed inflation pressure will force Chinese Central Bankers to tighten liquidity. In such a scenario, a meaningful decline in GDP growth is very likely.
Further, if bad loans show an rising trend, there might be relative risk aversion in the banking system leading to decline in credit growth. On the contrary, the large banks being government controlled, the loans growth and absorption of losses (through roll-over to local governments) related to bad loans might be relatively longer than expected.
However, the sustainability of growth through the process discussed above is very unlikely and China's GDP growth should decline meaningfully in the foreseeable future.
In my opinion, for the question related to investment in fixed assets, the sustainability of such a large scale investment is questionable. The concern is that if the investments in fixed assets drops, GDP growth will be significantly impacted. Nearly 50% of the GDP growth in China is currently coming from investment in fixed assets.
Making investment in fixed assets might still sound and work fine for a country where infrastructure development is still impending. However, the returns for the banking system on these investments is very questionable. The revenues derived from many infrastructure projects might be insufficient to even cover the cost of the projects.
Therefore, a more desirable scenario would be a accept a slowdown and boost internal consumption (a process, which will take time). The current growth model looks unsustainable in the medium-term. Further, the consequences of easy money might not be very pleasant for the financial system.
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