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Finance & Economy

China risks following Japan into economic coma


A salesperson, dressed as the Chinese god of fortune, hands out leaflets for a jewellery shop at a shopping district in Beijing

A salesperson, dressed as the Chinese god of fortune, hands out leaflets for a jewellery shop at a shopping district in Beijing

After decades of emulating Japan‘s export-driven economic miracle, China appears in danger of following it into the same kind of economic coma that Japan is trying to wake up from 20 years later.

China is struggling to wean itself off a habit picked up from its more advanced neighbour: relying for growth on exports and credit-fuelled investment. That has left its economy lopsided, economists say, with massive over investment in property and industries rapidly losing their cost advantage, from mining and electronics to cars and textiles. Wages are rising, the return on investments falling.

With growth slipping, China’s President Xi Jinping and Premier Li Keqiang seem determined to avoid a U.S.-style financial crisis, complete with widespread bankruptcies and job losses.

Preventing such a crisis though could embalm diseased sectors, stifling efforts to make growth more sustainable and instead create the kind of “zombie” banks and companies that sucked the life out of Japan’s economy, economists say.

Add a population graying faster than Japan’s did, and economists worry China may be attempting the impossible.

“There is a huge amount of denial. People think that demographics don’t matter,” said Chetan Ahya, chief Asia economist at Morgan Stanley in Hong Kong. “I’m worried about the deflationary risk.”

Deflation may seem unlikely in an economy still growing at a 7.5 percent clip and where consumer prices are rising 2.7 percent a year. But economists warn that China in many ways resembles Japan in 1989, two years before its crash.

Like Japan, China relied on banks to funnel investment into export industries to create jobs and finance development. In return, interest rates were regulated to ensure banks a healthy profit. Because the most profitable loans were those to the least-risky borrowers, banks concentrated their lending on big state-owned companies.

As Japan did in the 1980s, China tried to remedy this by partially liberalizing the financial sector, creating new avenues of finance, a bond market and other non-bank lending. But as in Japan, this encouraged banks to lend more, not more wisely, helping fuel a property bubble. Things got worse in 2009, when China launched a 4 trillion yuan, credit-powered stimulus to ward off the global crisis.

While Japan saw credit expand from 127 percent of GDP to 176 percent between 1980 and 1990, China’s credit rose from 105 percent in 2000 to 187 percent of GDP last year, JPMorgan Chase in Hong Kong says.

CREDIT RISKS

China’s problem now is that each yuan of new investment is yielding a diminishing amount of new GDP. The slowdown is already creating signs of deflationary pressure: producer prices have been falling for 16 months and Morgan Stanley notes that real borrowing costs of 8.7 percent are outpacing the sector’s growth.

One risk, therefore, is that China’s reforms push growth low enough to trigger a wave of defaults that shakes the entire financial system.

“It’s very important to slow down the growth of credit,” said Grace Ng, senior China economist at J.P. Morgan in Hong Kong. “But if we slow and de-leverage too much you could have too much downside risk on the real economy.”

The bigger risk, she and others caution, is that to avoid social unrest Beijing refuses to tolerate such pain, instead encouraging banks to keep troubled borrowers afloat by rolling over their loans like Japan’s banks did in the 1990s, preventing them from lending to profitable new ventures that could revive growth.

Beijing’s recent efforts to blunt the slowdown are thus drawing mixed reviews. Last week’s announcement by Premier Li that Beijing would cut taxes on small businesses and red tape for importers is seen as welcome restructuring, while boosting credit for foreign trade and speeding up railway investment smacks of mini-bailouts.

Likewise, some economists saw the central bank’s move this month to eliminate a floor on lending rates as a positive step towards making banks price loans according to their risk. Others saw Japan-style “regulatory forbearance,” a way to help banks refinance loans for their best customers so they can pass the savings to needier borrowers of their own.

“Since profit margins will be cut, banks will try to increase lending volumes by reducing their credit standard,” said Wataru Takahashi, a former Bank of Japan official who is now a professor at the Osaka University of Economics. “This is the story of the Japanese banks in the late-1980s.”

JAPAN COULD OFFER SOLUTION TOO

Some economists caution against exaggerating the similarities. “Comparing it to Japan in the 1990s is a little bit too much,” said Changyong Rhee, chief economist at the Asian Development Bank in Manila.

China’s lower development, Rhee and others say, gives it a reservoir of demand that affluent Japan did not have. China’s poor, inland provinces do not suffer from overcapacity and it will not take long before China needs the infrastructure projects that now might look like white elephants.

China’s push to move more citizens into its cities represents another source of growth.

But lower development also makes it harder to weather weak job growth or stagnant wages. And urbanization may not be as potent as it once was: with more than half of China already in the cities, the median age in rural areas is roughly 40, not a demographic prone to relocating for new career opportunities.

Ultimately, it may be demographics that put China most firmly on Japan’s deflationary trail. Thanks to its one-child policy, China’s working age population is already shrinking. That’s what happened to Japan in the 1990s, resulting in lower consumption and sharply lower growth rates.

The solution may lie – where else – in Japan, where the government is fighting deflation with aggressive new policies to lower borrowing costs, by boosting government spending and, though it has implemented few of them yet, by removing bottlenecks to growth.

“Two things are needed to avoid deflation after a credit binge,” said Ahya at Morgan Stanley. “One is good fiscal and monetary response and the second is structural reforms.”

Source: Reuters “Analysis: China risks following Japan into economic coma”
 
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About chankaiyee2

Author of the book "Tiananmen's Tremendous Achievements" about how with the help of Tiananmen Protests, talented scholars with moral integrity seized power in the Party and state and brought prosperity to China. The second edition of the book will be published within a few days to mark the 25th anniversary of Tiananmen Protests All the parts in the first edition remain in the second edition with a few changes due to information available later and better understanding. There are also some changes for improvements of style. The new parts are Chapters 12-19 on events in China after the first edition was published: The fierce power struggle for succession between reformists and conservatives; Xi Jinping winning all elders’ support during his mysterious disappearance for 2 weeks in early September, 2012; and Xi Jinping Cyclone. Chan Kai Yee's new book: SPACE ERA STRATEGY: The Way China Beats The US An eye-opening book that tells the truth how the US is losing to China. The US is losing as it adopts the outdated strategy of Air-Sea Battle while China adopts the space era strategy to pursue integrated space and air capabilities: It is losing due to its diplomacy that has given rise to Russian-Chinese alliance. US outdated strategy has enabled China to catch up and surpass the US in key weapons: Hypersonic weapons (HGV) that Pentagon regards as the weapon that will dominate the world in the future. Aerospaceplane in China’s development of space-air bomber that can engage enemy anywhere in the world within an hour and destroy an entire aircraft carrier battle group within minutes. Anti-satellite (ASAT) weapons, anti-ASAT weapons, stealth aircrafts, drones, AEW&C, etc. The book gives detailed descriptions of China’s weapon development based on information mainly from Chinese sources that the author monitors closely. U.S. Must Not Be Beaten by China! China is not a democracy. Its political system cannot prevent the emergence of a despotic leader or stop such a leader when he begins to bring disasters to people. A few decades ago, Mao Zedong, the worst tyrant in world history did emerge and bring disasters to Chinese people. He wanted to fight a nuclear war to replace capitalism with communism but could not bring nuclear holocaust to world people as China was too weak and poor at that time. If a despot like Mao Zedong emerges when China has surpassed the US in military strength, world people will suffer the misery experienced by Chinese people in Mao era. China surpassing the US in GDP is not something to worry about as China has the heavy burden to satisfy its huge population, but China surpassing the US in military strength will be world people’s greatest concern if China remains an autocracy. US people are of much better quality than Chinese people. What they lack is a wise leader to adopt the correct strategy and diplomacy and the creative ways to use its resources in developing its military capabilities. I hope that with the emergence of a great leader, the US can put an end to its decline and remain number one in the world. China, US, space era strategy, air-sea battle, space-air bomber, arms race, weapon development, chan kai yee

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