China’s handling of its 10.7 trillion RMB in local government debts is typical of this imbalance in the economy. In early February, the central government asked Chinese banks to roll over local government debts that accrued during the massive recession-fighting stimulus binge in 2009 — essentially sweeping them under the rug for a later reckoning. More than half of those loans are to come due over the next three years.
By far, many analysts say, the biggest shift required is a redistribution of resources that will unleash the potential spending power of the Chinese public. “China needs to rebalance the composition of its GDP more toward consumption, develop a more market-based monetary policy, reduce the excessive privileges of state-owned enterprises, ease income inequality and focus on promoting more productive and environmentally friendly industries,” according to Rob Subbaraman, chief economist with Nomura International in Hong Kong. Moving toward a more market-based monetary policy, involving a more flexible exchange rate and deregulated interest rates, would push bank deposit rates higher, helping to reduce the need for saving and also improving investment options so that families do not rely so heavily on real estate to grow their nest eggs. Meanwhile, the government needs to make the politically difficult choice of reducing preferential treatment for state companies, which now includes preferential access to bank credit and government subsidies of land, labor and electric power. The aim is “to redistribute income from the corporate sector to the household sector,” he says.
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Subbaraman sees a one-in-three likelihood of a hard landing and believes China could resort to extra stimulus spending to avert such a worst case scenario. But without the necessary reforms, the stimulus money would just go to waste, he notes. “The key with future fiscal stimulus is to direct it more efficiently at consumption and more productive areas of investment.”
Repairing the Net
Apart from the overall structure of the economy, another key reason for the Chinese obsession with scrimping and saving is the dire lack of public services and social welfare. Education, likewise, is a huge cost for most families. “Right now, taxes are too great a burden for households and the private sector, while China spends too little on social security, medical care and education. There is a lot they can do there,” says Yao.
Meyer agrees. “There is room to repair the social safety net. Since there is not adequate medical care and social security in China, people feel they have to save 40% to 50% of their income. If they feel they have some safety net in their old age, they will be less prone to save.” As China’s population ages, it will have a growing need for services for the elderly, and spending on such areas will increase if the supply is there to meet demand, Meyer says. “You can increase consumption if customers get what they want.”
In fact, Bottelier sees China’s services sector as one of the most powerful potential engines for growth, and one that has not been fully realized. “Even at lower growth rates of 6% or 7%, China can maintain full employment if the contribution of the service sector to the economy expands more rapidly than the contribution of construction or manufacturing. You can get more growth in the service sector per dollar invested,” Bottlier says. He views such changes as inevitable. “We have to see how China responds to this in coming years. If they postpone [these kinds of reforms] again, messy political consequences will be waiting.”
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Overall, the consensus among most economists is that it is time for China to bite the bullet and move ahead on politically difficult, painful reforms that could lay the foundation for sustainable growth in the future. It would not be the first time: In the 1990s, then-Premier Zhu Rongji carried out the first big overhaul of state industries, laying off millions of workers. Housing reforms helped create a commercial property sector from scratch that, despite its ups and downs, has helped establish a growing middle class. Given the strong hold of vested interests, especially at the local level, such changes are difficult but necessary for a rebalancing of the overall economy, notes Chovanec.
“My advice [to the government] is to drop this obsession with high-level GDP growth,” Chovanec says. “Driving 8% to 9% GDP growth through investment may not pay off, and is not in the long-term interests of anyone in the Chinese economy. Accepting lower rates of expansion is a first step to putting China on the path toward long-term, sustainable growth.”