Chinese Economy: Tapping the Brakes?
Stratfor Summary
China's central bank plans to raise the bank reserve ratio for
the second time in seven months. A more important -- though less
publicized -- event was the bank's warning that it would begin
cracking down on insider loans to "affiliated persons." That
crackdown, rather than changing official lending policy, will be
the proving ground for whether Beijing is willing and able to
rein in the Chinese economy -- and the implications will extend
far beyond China's borders.
Analysis
The People's Bank of China plans to raise the reserve requirement
for all banks from 7 percent to 7.5 percent. The change will be
effective April 25. The decision coincides with and expands a
March 24 announcement that raised the reserve requirement for
some substandard financial institutions. The bank said the latest
change will remove some 110 billion yuan ($13.3 billion) from the
financial system, which theoretically would limit new lending and
slightly reduce inflationary pressures. China last raised the
reserve requirement from 6 percent to 7 percent in September
2003.
The decision is part of a wider effort by Beijing to take money
out of circulation in an attempt to cool the economy and ease
inflation pressures, which have been driven up sharply over the
past two years by massive new lending for capital investment
projects. Those projects include everything from new steel and
automobile factories to massive and often speculative real estate
ventures.
The combination of foreign investments and domestically financed
projects has driven the Chinese economy close to double-digit
growth rates. Beijing will take all the foreign investment it can
get, but the government worries that domestically financed
projects are generating unhealthy bubbles in the economy and
financial system similar to those seen in the mid-1990s.
China's financial system, which is already riddled with bad
loans, is in no position to withstand the bursting of a real
estate bubble or the sudden market realization that key Chinese
manufacturing sectors are vastly overbuilt. Struggling on the one
hand to dress up its largest banks for a planned coming out party
this year or next, the last thing Beijing needs is a new flood of
bad loans into the system and/or a loss of market value in
underlying assets that a market crash could bring.
The party leadership is sincerely worried about the possibility
that the economy could overheat -- leading to dangerous
overcapacity and a sharp rise in inflation, followed by a nasty
crash back down to earth. Such a scenario would challenge
Beijing's ability to hold the politically fragile Middle Kingdom
together while undermining China's wider geopolitical ambitions.
Following the latest meeting of China's State Council, presided
over by Premier Wen Jiabao, the government released a warning of
"serious problems" from what it called blind, or overlapping,
construction projects, according to Xinhua. The new reserve
requirements came two days later.
So far, Beijing has had a tremendously difficult time slowing
down the roaring economic train. Despite last September's full-
point increase in the reserve requirement and other measures --
primarily tough talk -- to slow the pace of lending, capital
investment has only strengthened: Overall, fixed-asset investment
in China rose 53 percent in January and February from the same
period in 2003, with real estate investment over the same period
up 46 percent. Within that, China's State Development and Reform
Commission estimates investment in steel production jumped 173
percent for the same period, Xinhua reports.
There are several forces that likely explain Beijing's failure to
curb capital investment. One is sheer momentum. Like all booms,
such as the U.S. gold rush or the high-tech explosion of the late
1990s, the China boom has generated irrational exuberance and the
hunger to get in quickly while the getting is good. That force is
compounded by the general immaturity of the Chinese economy and
China's business leaders, which lack the mechanisms and
experience to rationally and efficiently judge what is viable
from what is not. If one automobile plant is good, 10 plants must
be better.
Perhaps the most dangerous and powerful driving force behind new
loans to questionable projects that Beijing must contend with is
the mix of corruption and shady relationships that interlocks the
Communist Party, state-owned enterprises (SOEs), the Chinese
banking sector, and the wider business community. Those
relationships drive the flow of billions of dollars from China's
banks to commercial projects, and corrupt bank officials and
their associates suspected of skimming large amounts off the top.
This embezzling -- along with the fact that Communist Party
officials often have vested interests in the projects -- is a
major motivation to keep the lending taps open.
The central bank and the China Banking Regulatory Commission
jointly issued new rules April 7 designed to address this problem
directly. Beginning May 1, commercial banks will be limited in
the proportion of loans they can offer to "affiliated persons" --
including bank managers, major shareholders and other big
customers who have personal or familial connections to banking
executives.
Beijing already is stepping up its anti-corruption campaign
within the Party with widespread arrests of SOE managers. It
could look to extend that crackdown more specifically to bank
officials. If Beijing wishes to truly address the lending
situation and give teeth to the new rules, it will have to make a
show of force, handing out large fines, sacking some bank
managers and arresting other managers, some quite senior. Whether
these key changes come about will be a primary indicator of how
serious the Party really is about dialing back on continued bad
loans and, in the process, growth and investment.
The outcome of the coming battle will have implications far
beyond China's borders.
China's investment boom has fueled a rapid rise in raw materials
imports that -- along with the wider global expansion -- has
pushed up key commodities prices across the globe and is driving
new investments in ports and other transportation infrastructure
from Australia to Africa to South America.
If Beijing is successful at rationalizing its growth levels,
those material imports could begin to fall off. Considering the
daunting task facing the government -- and China's economic
momentum -- that will not happen immediately. Still, any signs
that growth rates are leveling off will begin to impact China-
focused commodity markets on a psychological level.
If Beijing fails to gain control over capital investment, and if
lending to questionable or "redundant" projects continues at the
current pace, commodity prices will remain at historic highs and
inflation could gain momentum in China -- and across Asia. To
some extent, this is already happening. In China, the central
bank's corporate goods price index, which measures the prices
that companies pay for goods from other companies, jumped by 8.3
percent in March compared to the same month in 2003. Consumer
inflation is still low -- only a couple of years ago China was
worried about deflation -- but it too is on the rise.
Assuming the bubbles do not start bursting, China and other Asian
exporters could begin to export producer price inflation to their
main customers, including the United States and Europe. With
Chinese goods making up an increasing percentage of the retail
mix in the big Western consumer markets, this could spur consumer
price inflation, which could prompt a rise in global interest
rates. While it is a long way from here to there, Beijing's
willingness, ability and success in truly tackling entrenched
corruption in its lending practices will have a global impact. |
