Sat, Mar 24, 2012 page8

• Chinese economy reveals problems

  • By Norman Yin 殷乃平
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  In his official report to the National People’s Congress on March 5, Chinese Premier Wen Jiabao (溫家寶) said that China’s economic growth target for this year would be 7.5 percent. This is the first time in eight years that the State Council has set growth below 8 percent and is an indication that the current wave of economic expansion is beginning to ebb.

  The yuan has been gradually but steadily gaining value ever since Beijing introduced currency reforms in June 2005. There was a pause in the yuan’s rise between the middle of 2008 and June 2010, following the global financial crisis, but its upward trend has picked up again after that. In the second half of last year, the European debt crisis caused a US dollar liquidity crunch around the world, driving the yuan up against the greenback, which in turn rose against other currencies. China’s exports were severely affected by the strengthening yuan. Exports surged 37.6 percent in January last year, but by December this rate had fallen to 13.4 percent. Exports further contracted in January this year. Although they rose again last month, taking the figures for the first two months of the year together, they only rose 7 percent. In other words, the rate of growth of China’s exports continues to fall.

  The European debt crisis, combined with financial adjustments in the form of deleveraging by financial institutions around the world, has led to a tight supply of US dollars in global markets. Since October last year, foreign investors have been pulling out of China. On Nov. 7, the value of the yuan fell and although it rose again toward the end of that month, the fall had already prompted an outflow of “hot money” associated with interest arbitrage. According to unofficial estimates by currency traders, the capital outflow may have been close to US$400 billion. The yuan’s volatility on currency markets has had an impact on the mainly Hong Kong-based offshore yuan market. The market for “dim sum bonds” — ie, yuan-denominated bonds issued in Hong Kong — has been unstable, while the difference between the yuan’s offshore and domestic exchange rate reached 2 percent for a while. The SWIFT international interbank payment network warned of the risks of a yuan market collapse and advised member institutions to set up emergency response mechanisms should anything go wrong.

  However, China’s real problems are domestic. Thanks to its longstanding trade surplus, China has accumulated huge foreign currency reserves. Its M2 money supply has grown by an average of more than 17.5 percent per year over the past 10 years, swelling 28.4 percent in 2009 alone. With inflation exceeding 6 percent last year and an average interest rate of 3.5 percent on one-year deposits, the real interest rate is negative. Consequently, market demand for lending is quite high. China’s central bank, the People’s Bank of China, was forced to introduce monetary-tightening measures, raising the reserve requirement ratio for lending institutions no fewer than 12 times to a high of 21.5 percent last year. At the same time, the central bank used bond issues and open-market operations to reduce the upward pressure on foreign currency reserves.

  However, the most effective measure was direct credit regulation vis-a-vis banks’ prospective borrowers and loan types. Taking the central bank’s reserve of 79 trillion yuan (US$12.5 trillion) as of October last year, for example, 53.4 trillion yuan of it was lent out, 17 trillion yuan paid over to the state as a deposit reserve and 3.8 trillion yuan in the form of central bank bills, leaving just 4.8 trillion yuan in working capital available to the bank. If foreign investors were to withdraw US$400 billion from China, there would only be 2.3 trillion yuan in accessible funds left within the financial system. That is why Chinese financial institutions started feeling a cash squeeze from April last year onward. Although China has slightly eased its currency policy, it is hardly enough to resolve the money shortage.

  When banks face a high demand for funds, but money supply is tight, funding to support economic expansion is sure to get priority. China’s 12th five-year plan involves heavy investment by the state. Tens of thousands of kilometers of high-speed rail are to be built over five years, while China’s Ministry of Railways was 2 trillion yuan in debt last year. About 50 cities plan to build underground railways, and money will be invested to establish 1 million or more Wi-Fi hotspots. Local governments are investing in land procurement and reclamation, real-estate development, golf courses and so on. All this is in addition to state-run enterprises’ funding needs. Where state-owned enterprises move forward, private companies will have to step back and will face difficulties.

  Problems emerged first in the freewheeling southern coastal city of Wenzhou. Under pressure from a stronger yuan, many companies in Wenzhou could not attract export orders. Some company bosses started absconding, while many firms went bankrupt. Next, shipyards in Wenzhou started experiencing problems, and the owner of Dongfang Shipbuilding Co, a company listed on the London Stock Exchange, was reported to have fled. Nearly 20 percent of Chinese companies listed on the US’ NASDAQ and New York Stock Exchange have been having difficulties. These problems have started to spread across the Yangtze Delta and on into Hunan and Sichuan provinces, and other places. At the same time, local governments bear excessive debts that they cannot pay back. After foreign media exposed this problem, these places have put off the problem by extending repayment deadlines. Of course that is not the end of it — China’s basic economic structure is riddled with these problems.

  All in all, as the tide of China’s economic growth recedes, underlying problems are being revealed one by one. For a long time, the economy was growing so fast that there was no time to pay attention to various kinds of planning, both concrete and institutional. Now that the tide is ebbing, these aches and pains will have to be dealt with. How should China go about opening up its financial market? What plans should there be for developing capital markets? How can domestic and external conflicts arising from the internationalization of the yuan be resolved? How can undesirable side effects of economic weaknesses and restructuring be avoided?

  With a handover of political power from one generation to the next approaching, the Chinese government desires stability above all else. As Confucius wrote: “The tree would prefer stillness, but the wind continues to blow.” The problems will not go away of their own accord and this year promises to be a year full of challenges for China.

  Norman Yin is a professor of financial studies at National Chengchi University.

  Translated by Julian Clegg
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