beyondbrics

By Ben Simpfendorfer of Silk Road Associates

The chairman of a large Chinese construction company recently commented about the increase in spending on public housing: “The government is satisfied. The people are happy. And the banks all benefit, as the company will not lose money”.

His comment could be a slogan for 2012’s outlook: and it’s both good and bad news.

The good news is that China has plenty of scope to increase its debt-financed spending should it have to support GDP growth in 2012, and that includes spending on public housing.

Sure, bad debts have increased in recent years. But government debt, estimated at around 58 per cent of GDP, is still tolerable relative to levels in the developed world. Household debt is also remarkably low at 28 per cent.

To be fair, non-financial corporate debt is higher at 91 per cent of GDP, even before accounting for loans made by the shadow banking system. But that figure compares to 76 per cent in the United States and 125 per cent in Europe.

The bad news is that any increase in debt-financed spending will be channelled through the same old vehicles: state-owned companies and local governments.

Ideally, consumers would step up and take out more auto-loans or use their credit cards more frequently. Yet, that isn’t going to happen soon, even if attitudes towards debt are changing among the younger generation.

It helps that last week’s Q4 GDP figure was firmer than expected.

But worse is to come with the property sector still under pressure and the export sector weakening. Odds are then that China may consider modest stimulus again in 2012.

Yet, any increase in public debt must be accompanied by economic reform, the latter having lagged over the past decade, but especially since the global crisis.

Economic reform is necessary to wean the economy off its reliance on the state-sector: further liberalisation of the service sector; improved credit availability for SMEs; better protection of IPR. These changes will all help revitalise the private-sector.

If not, more public spending will simply result in an increasingly state-dominated, low-margin, economy: a feature of growth in the past five years.

Take the housing market as an example. More public housing is indeed needed: it’s crucial to social stability. Yet, public home builders have profit margins of just 8 per cent to 10 per cent, as against margins nearer to 20 per cent for private home builders.

Neither is spending on public housing a productive investment, meaning the government must simultaneously encourage the private sector to increase its own investment spending, whether that’s buying a machine tool or computer network.

The latter type of spending is vastly more productive and so is crucial to maintaining China’s double-digit nominal GDP growth over the medium-term, and help the country to grow its way out of any legacy bad debt problems.

So, while fears of a hard landing in 2012 are overdone, the risks to 2013-15 continue to grow, especially if more stimulus is needed to counter weaker global growth and should economic reforms lag amid a political transition.

Ben Simpfendorfer is Managing Director of Silk Road Associates, a Hong Kong-based economic consultancy. He is also publisher of the monthly “China Insider” and author of “The New Silk Road”.

Related reading:
China’s local governments dig deeper, FT Alphaville
Investors warned of Chinese bond risks, FT
Cogs of China’s credit machine grind more slowly, FT
Sino-Forest faces battle with bondholders, FT
China’s property sector goes from bad to worse, FT Alphaville