The real problem: China is suffering a case of financial constipation. Crimped profits and rising overdue loans are pressuring the ability of the banking sector to allocate capital to where it’s needed most. The majority of credit is being funneled into deadbeat borrowers refinancing their loans—not to the growth businesses of the future. Debt service costs have risen to 15 percent of GDP—just short of record highs—according to CLSA. Interest rate cuts are holding this ratio down. Yet more and more credit is required to keep up growth. This suggests monetary policy is losing its potency. Will fiscal policy come to the rescue? More stimulus such as infrastructure spending could boost nominal GDP by up to 2.5 percent over the next two years, I estimate. Yet the effect could be muted given a reliance on local governments to implement spending plans. The intensifying anti-corruption purge and arrests of prominent finance executives after the recent stock market crash have instilled fear in local government officials. The result could be policy paralysis.
Market Realist – Financial sluggishness is definitely one of the biggest weaknesses in China. As discussed in the previous part of the series, debt is largely held by local governments and state-owned enterprises rather than households. But this does not let China (EWH) off the hook. The government can withstand a potential crisis by rolling over loans, but this threatens the effervescence of the economy. According to Anne Stevenson Yang, co-founder of J Capital Research, 60-70% of new lending is being used to service old debt obligations, instead of stimulating the economy. In 2006, $1.2 in loans could spur economic growth worth $1. Now $3 in loans is required to spur economic growth worth $1.
There are broad macroeconomic factors at work too. China’s (FXI) one-child policy has wreaked havoc on its demographic profile. The policy, originally undertaken to curb China’s population levels, is now also affecting the economy. Lack of young workers willing to undertake arduous professions has pushed up the minimum wages in China (ASHR), crimping profits and affecting China’s (GXC) position as a global outsourcing destination. The previous graph shows how minimum wages are currently at an all-time high of 2020 yuan per month.
Moreover, the policy has increased the pressures of an aging population on the Chinese economy. According to forecasts from the United Nations (or UN), China will see a reduction of 67 million working-age citizens by 2030, whereas the elderly population will double.
Repealing the policy may be a step in the right direction. But the positive effects would take time to emerge. Moreover, previous easing in the population policy has not had the desired effect. China’s birth rate continues to remain at 13, which is on par with higher income developed economies (EFA).