Here’s some terrific news about China’s economy: at the end of last year, the debt-to-GDP ratio of the Chinese government, the key measure of its fiscal sustainability, stood at 16.3%. That’s an improvement from the already impressive 17% at year-end 2010.
Based in large part on Beijing’s low debt load, the Economist’s “wiggle-room index,” which ranks economies on their ability to afford stimulative measures, assigns a great rating to China. Of 27 emerging nations, only petroleum-blessed Saudi Arabia and Indonesia look stronger.
China does not have as urgent a need to bolster growth as other newly developing countries, the Economist suggests, and in any event it has lots of space to wiggle. “China’s ample room for easing supports the case for a soft rather than a hard landing of its economy,” the publication says.
All this sounds wonderful, but none of it correlates with the facts. The 16.3% calculation excludes Beijing’s “hidden liabilities.” Once you add them in, China’s debt-to-GDP ratio increases to somewhere between 90% and 160%. And if you believe Beijing has been overstating its GDP recently—it has, at least starting from the last quarter of last year—China’s ratio approximates Greece’s 164%.
Analysts, surprisingly, don’t seem to be concerned about Beijing’s debt, no matter how it is calculated. As Tom Holland of the South China Morning Post points out, the assumption is that China can grow its way out of this problem because it has always been able to do so in the past.
China’s economy, despite the Economist’s assessment, is already landing hard. January’s results were dismal—the economy looks like it may even have contracted last month—and there will not be much improvement until the summer, if then. If there is no marked uptick this year, Beijing faces difficult choices because, as
the “ghost city” phenomenon indicates, there has been a gross misallocation of capital since the end of 2008.
What are Beijing’s choices? First, central government technocrats could force the banks to absorb losses. At first glance, it appears the banks could afford substantial write-offs.
The industry’s non-performing loan ratio was 0.96% at the end of last year, down from an already unbelievable 1.14% at the end of 2010. Yet the central government will not force banks to write off large quantities of loans because the year-end 2011 ratio does not reflect the real state of bank balance sheets. The Ministry of Finance could again recapitalize the banks, but that may not be feasible. The central government has yet to clear all the bad loans from the big bailout at the end of the 1990s. China’s hidden liabilities include warehoused loans from that era, which Holland estimates amount to 7.5% of GDP.
So there is no or minimal growth, the banks are not strong enough to shoulder significant losses, and the central government is weighed down by 1990s-era bad loans. What is a central government technocrat to do?
“Beijing can take the path traditionally followed by other governments around the world and inflate its way out of the problem,” Holland wrote on Friday. The general downward trend in consumer inflation looks to offer some flexibility, but prices—and especially those for food—are going up much faster than the numbers issued by the Bureau of National Statistics indicate.
It would be easy to create more inflation. The renminbi has strengthened recently, but most analysts believe Beijing will end the upward movement in the next few months, in large measure to rescue ailing export factories, to make Chinese products cheaper on world markets. The inevitable result of a depreciating currency would be inflation, which would help the central government erode the value of its mounting debt.
Of course, China’s citizens, who accumulated 37.0 trillion yuan in household deposits by the end of last month, would be hurt by this tactic, but for more than three decades Beijing, by fixing deposit rates at abnormally low levels, has maintained an economic model that has punished them to help borrowers. Low deposit rates would depress consumption by keeping money out of the hands of citizens, but Chinese leaders have never been serious about building a consumer economy. In no economy today does consumption play a lower role.
And in a China where everything is political, there is one more factor to consider. Communist Party leaders are extraordinarily sensitive to inflation due to its potential to create widespread social unrest.
So, yes, there would be many disadvantages to using inflation to solve China’s debt situation, but at this moment it looks like the least bad option for Beijing’s out-of-solutions technocrats. The Economist may believe they once had lots of room to wiggle, but their choices are all unpalatable—and they are narrowing fast.
How Will China Pay Off Its Debt? - Forbes
