China’s Hard sell – Moody’s Worries

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China sees no reason to lose sleep over Moody’s worries over its growing debt.  The total debt of the country reached 256 percent of economic output at the end of last year. It has not been hidden under the Little Red Book of Mao Zedong, whom some hail as the Great Helmsman while some others dub as the Ruinous Dictator.

Well, the world mesmerised by President Xi Jinping’s plans to bank roll the multi-billion dollar One Belt One Road (OBOR) initiative, has reasons to raise its eyebrows in disbelief. These sections have no forewarning of Moody’s decision to downgrade China’s sovereign debt rating by a notch. This is clear from the turnout the summit President Xi hosted in Beijing on May 14 and 15 to hard sell his new Silk Road dreams for cash and clout.

Will the new credit rating put brakes on China plans?  Frankly, there are no ready answers. One thing is clear though. Sceptics of OBOR will have a field day.   Will they succeed? It depends on how the Chinese marshal their energies to blunt the Moody’s critique and how the Chinese sweeten the deals for the cash strapped low income countries, which have come to see their infrastructure nirvana in OBOR.

BEIJING SUMMIT

OBOR stands for linkage through land and sea. It is a $124 billion venture to build ports, railways, airports and power plants in South Asia, Central Asia, West Asia, Africa and even Southern America -virtually in every corner of the world. Yes with Chinese manpower. And with Chinese loans. There is no free lunch in the Globalisation Mark Two.  

At the Beijing summit, President Xi made some irresistible offers.  One China will import US $ 2 trillion worth of products from belt and road countries in the next five years.  Two another US $14.5 billion will be infused into the Silk Road Fund. Three China will provide 60 billion Yuan in the next three years for poverty alleviation in developing countries along the new Silk Road.  Four the China Development Bank and the Export-Import Bank of China will chip in with 380 billion Yuan worth special lending schemes.

All these moves are carefully crafted to propel China to the centre stage of the global power where a vacuum of sorts is emerging with President Donald Trump’s aversion to Globalisation Mark One and his resolve to make the US not to look beyond its nose.  Xi has thus made “a sharp departure” from the approach of his predecessors, who had strictly adhered to Deng Xiaoping’s tenet to “hide our capabilities and bide our time, never try to take the lead”.

You need not necessarily turn to a regular China watcher to decipher Xi’s moves. His out of the box thinking, as some would like to dub his plans, was a result of absolute necessity – Chinese economy inching towards the mode Greece and Spain were in “in the  years preceding their steep economic nose-dives amid the global financial crisis”.

UNRELIABLE DATA

Like the Soviet Union yesterday, China today frustrates the world when it comes to data on economy. “There is no statistics less credible than the nation’s official unemployment rate”, said business magazine Fortune in August 2015. Said the Financial Times, also in 2015: “China’s official unemployment statistics are the worst of a notoriously unreliable set”.

The US National Bureau of Economic Research avers that China’s real unemployment rate is much higher than the official rate and, when correctly measured, is much closer to that in other nations at similar levels of development. Its working paper on “Long Run Trends in Unemployment and Labour Force Participation in China”, (NBER Working Paper No. 21460) estimates that the actual unemployment rate in 2002-09 averaged nearly 11 percent, while the official rate averaged less than half that.

Going by official Chinese data, the unemployment rate has fluctuated between 4% and 4.3% even when the quarterly, year-over year growth has been as high as 14% and as low as 6%.   High and rising unemployment in China created by massive layoffs during major changes in the structure of the labor market is not reflected in government figures.

The jobless rate may be three times the official estimate, according to Fathom Consulting; its China’s Underemployment Indicator has tripled to 12.9 percent since 2012 even while the official jobless rate has hovered near 4 percent for five years.

Forget about unemployment data, even the official population numbers appear doubtful. The real population of the country may be 1.29 billion, 90 million fewer than the government’s estimate of 1.38 billion in 2016, says Yi Fuxiang, a Chinese demographer based in Wisconsin. In his assessment, India may be the Number One country, population-wise, not China.

FUDGING STATISTICS

Fudging statistics or speaking up statistics is a virtue behind the bamboo curtain in Communist China which swears by the dictum of   Deng Xiaoping, “Whether a cat is black or white makes no difference. As long as it catches mice, it is a good cat”. And his reforms were a one –way street!

Two recent headlines with Beijing as dateline highlight the flipside of the Chinese economy. One headline read: “Shadow Lending Threatens China’s Economy, Officials Warn”. The second headline was no less dramatic: “Chinese Investment Scandal Highlights ‘Shadow Banking’ Risks”.

Shadow banking, as the expression indicates, is lending that takes place outside the regular banking channels. It has become a time bomb, as more and more people, business men including, are turning to this unregulated channel for easy, hassle free loans. “Many of these lending platforms offer big returns and accept minimum contributions low enough to entice common workers. They have disclosed fairly little about how they will invest the money they raise”, a report said.

Another Chinese banking innovation is entrusted loans, which have seen spectacular growth. These are loans offered by one company to another through a bank to get around the official ban on Chinese companies lending directly to each other. These loans account for 9 percent of overall credit in China, according to Natixis, a financial services firm.

PONZI SCHEMES

There is no dearth of Ponzi schemes either.  Small investors lost more than $6.7 billion in a huge Ponzi scheme operated by an on-line finance company last year.

Bank China Minsheng, promised only to collapse, a return of eight percent to 27 percent with free golf events, and trips to exotic locations in South Africa as added bait to get deposits. A Shanghai investment firm last year made a tantalising offer: deposit just about fifteen dollars and get a return of up to 10 percent a year. The company is into real estate business, which, many analysts agree, is no more than a bubble.

The Chinese market is also flooded with uninsured wealth management instruments, which have attracted $2.8 trillion over the last five years. China is also home to a large number of Zombie companies. These are companies that need bailouts in order to operate. Some of them can pay back only the interest on the loans they had taken

The short point is that the Chinese economy is waiting with bated breath for the D-day. Today the Chinese have more money in circulation than the Eurozone and Japan combined.

RELIANCE ON DEBT

China has been the biggest beneficiary of globalisation. It has built its capacities across sectors, by expanding credit, primarily for the export market. As the West was gripped by financial crisis in 2008.  China went into an overdrive by spending and the spending was funded by credit.  To finance the construction, local governments and state-run companies borrowed heavily.

Even after the worst of the crisis passed, China continued to rely on debt to fund growth. This is turning out to be its Achilles heel with household debt alone amounting to 45 per cent of the GDP, nearly double 2009 levels.

Mortgages, consumer credit and so-called “operating loans” have witnessed sharp growth last year in particular, according to the Financial Times. And China’s addiction to debt appears to threaten its very growth and this is what is highlighted by Moody’s downgrade, the first since 1989.

There is one qualitative difference between China and other countries. China’s    debt is an internal time bomb with no external dimensions. In fact more than half of the bank debt in China is loans from state-owned banks to state-owned enterprises.  Lending policies can be fine-tuned but it entails the danger of factory closures.

Chinese Communist Party, with its credo of social security to the working class, cannot risk mass layoffs and thus fuel social unrest, and herald another Tiananmen Square show.  “Official policies prevent widespread firings, in turn letting unprofitable ‘zombie companies’ lock up broad swaths of the labour force by keeping them in limbo with shorter shifts and less pay”, says a report, which adds that underemployment is especially rampant at state-owned companies.

Now cut to OBOR. 

It is an initiative tailor-made to sustain the engine of Chinese economy. To insulate the labour market from the ravages of debt burden, and excess capacity and poor export show.

Well, China’s labour force is quite substantial at 800 million.

As the One Belt, One Road progresses, it will provide market for Chinese steel, cement, aluminium, and coal amongst other products on a scale that will be unprecedented. It will mean no layoffs at home. And an opening for gainful employment of the jobless and the underemployed Chinese. Their safety will provide a new market to the Chinese security firms.

With an estimated $ 3 trillion in forex reserves, China is cash rich. It will bank roll OBOR ventures at rates of interest often lower than the rate charged by the World Bank’s. Unlike the Brettonwoods twins, the Chinese government and its banks do not ask about human rights nor would they interfere with the local governments. This will give to Beijing a clout that has no parallel, and cannot be quantified.

This Alnaskar’s dream has a catch. Not one, but two, going by the experience of Islamabad with $ 62 billion 15-year project China Pakistan Economic Corridor (CPEC).

WINDFALL

Chinese loans will benefit China rather than Pakistan, and the Bamboo capitalist will end up as the proverbial Shylock, says a local commentator.

Take for instance the Sahiwal Coal Power Project.  The Chinese loan carries an interest rate of 6.21 percent (as the current one-year LIBOR is at 1.71 percent). Additionally, the China Export and Credit Insurance Corporation will charge an insurance premium of  7 percent though Pakistan government has committed itself to purchase electricity that will be generated. It means the Chinese earn 13 percent in the first year, Farrukh Saleem wrote in the News International (May 21, 2017).

This is a big windfall. Just from one plant under CPEC.

China has invested a trillion dollars in the US Treasury securities. The returns?  These are anywhere from 1.13 percent on a one-year treasury to a high of 2.98 percent on 30-year tenor.

The ranks of sceptics of OBOR/CPEC are therefore growing in Pakistan, which asserts that its friendship with China is “higher than mountains, deeper than the ocean, stronger than steel and sweeter than honey”.

Once the fine print is read, and the experience of Sri Lanka and a host of African nations with Chinese loans gains traction, scepticism will see a surge, and may prove the prophesy of Washington Post: “The top-down, autocratic nature of the belt and road plan and China’s self-interested structuring of the projects mean that it is likely to fall short of its aims.”

And it will be a double whammy to Beijing since financial stimulus alone cannot do wonders at the job market.  Echoes of 1989 protests staged at the Tiananmen Square in the center of Beijing may be heard once again in such a scenario.

No surprise, economist, Alex Tabarrok, once said: “Keep an eye on China and don’t be surprised by the unexpected”.

REFERENCES

  1. Moody’s Downgrades China over Worries about Its Growing Debt by Keith Bradsher in The New York Times, May 23, 2017 https://www.nytimes.com/2017/05/23/business/moodys-downgrades-china-economy-debt.html?rref=collection%2Fsectioncollection%2Fasia&_r=0
  1. China’s Addiction to Debt Now Threatens Its Growth, The NY Times, May24, 2017 https://www.nytimes.com/2017/05/24/business/china-debt.html?rref=collection%2Fsectioncollection%2Fasia&_r=0
  1. Moody’s downgrades China, warns of fading financial strength as debt stings, Reuters report, Mar 23, 2017    https://www.reuters.com/article/us-china-economy-rating-idUSKBN18K04Q
  1. China’s unemployment rate falls below 4 percent at end of first quarter, Reuters, Apr 25, 2017    http://www.reuters.com/article/us-china-economy-jobs-idUSKBN17R0JN

5. Chinese Investment Scandal Highlights ‘Shadow Banking’ Risks, By Sui-Lee Wee & Owen     Guo, Apr 19, 2017   https://www.nytimes.com/2017/04/19/business/china-minsheng-       shadow-banking.html

6. Shadow Lending Threatens China’s Economy, Officials Warn, By Keith Bradsher in NY         Times, Mar 18, 2017   https://www.nytimes.com/2017/03/18/business/china-economy-     debt-shadow-banking.html

  1. Doubts China’s Population Number, Saying India May Be No. 1, By Chris Buckley in The NY Times, May 24, 2017   https://www.nytimes.com/2017/05/24/world/asia/china-india-population.html?rref=collection%2Fsectioncollection%2Fasia
  1. China’s Trade Surplus Increased in April Imports and exports grow less than expected By Mark Magnier in The Wall St Journal, May 8, 2017 2:   www.wsj.com/articles/china-trade-surplus-widens-to-cny262-3-billion-in-april-1494214706?platform=hootsuite
  1. China’s Economy Slowed in April in ‘Turning Point’ by Mark Magnier in The Wall St Journal, May 15, 2017  https://www.wsj.com/articles/chinas-economy-slowed-in-april-in-turning-point-1494824130?platform=hootsuite
  1. Zombie companies still threaten China’s living- The Financial Times https://www.ft.com/content/b8870ec0-fdab-11e6-96f8-3700c5664d30
  2. Official Statistics Understate Chinese Unemployment Rate, National Bureau of Economic Research, USA http://www.nber.org/digest/oct15/w21460.html
  3. China Is Grappling With Hidden Unemployment, Bloomberg, Aug 22, 2016 https://www.bloomberg.com/news/articles/2016-08-21/behind-stable-job-data-china-grapples-with-hidden-unemployment
  4. China’s Hidden Unemployment Rate, Bloomberg, June 6, 2016 https://www.bloomberg.com/news/articles/2016-06-05/china-s-hidden-unemployment-rate.
  5. How China is exporting unemployment, Scott Paul, Prez, Alliance for American Manufacturing, Sept 8, 2016  www.cnbc.com/2016/09/08/how-china-is-exporting-unemployment-commentary.html
  6. Trillions in Murky Investments Could Rock China’s Economy, The New York Times, Aug 12, 2016  www.nytimes.com/2016/08/13/business/international/murky-investments-pose-china-risk.html?_r=0
  7. As China’s Growth Slows, Banks Feel the Strain of Bad Debt, By Neil Gougha, Apr 15, 2016 www.nytimes.com/2016/04/16/business/dealbook/china-economy-bad-loans.html
  8. What is the real unemployment rate in China: By Chris Matthews in Fortune, Aug 20, 2015   http://fortune.com/2015/08/20/china-unemployment/
  9. China’s New Silk Road Dreams in Cash & Clout, by the author in Power Politics; wwww.powerpoliticcs.in

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