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Economic Insights

Beijing faces a tricky task: tamping down excessive speculation while keeping credit flowing to key sectors of the economy.

June was a rough month for China’s economy and its financial markets. Old concerns about sustainable growth came to the fore, as reports surfaced and resurfaced, recounting liquidity shortages, misdirected and excessive credit growth, gyrating interest rates, and signs of weakness in manufacturing. Commentators and analysts alike voiced fears of a Chinese collapse on a par with America’s subprime crisis. For the second time in as many years, several in the global financial community have prophesized a “hard” landing for China’s economy. Though that country’s economy does confront many difficulties, including a tricky fundamental adjustment, these popular concerns surely overstate the downside. Likelihoods rather suggest that China will avoid financial collapse as well as the dreaded hard landing, even as Beijing pursues longer-term economic and financial reform.      

Though clearly China’s central bank, the People’s Bank of China (PBC), blundered in June, matters are far more nuanced than a simple policy mistake. China is trying to tailor policy to accomplish two contrary things simultaneously—a tough row for any policy team to hoe. On the one side, the authorities want to tamp down excessive real estate speculation and credit flows for dubious projects by provincial and local authorities. They also want to rein in lending by what they call “shadow bankers,” an uneven mix of trust companies, small lenders, leasing companies, and others, including, according to Zane Brown, Lord, Abbett Partner, Fixed Income Strategist, and Director of Asian Business Development, securitizations that can at times look very much like the subprime lending that plagued America five years ago. At the same time, the authorities want to sustain credit flows sufficient enough to support the country’s overall real growth target of about 7.5%. They also want to provide enough credit for China’s more fundamental effort to reorient the economy away from a purely export-driven engine of growth to a more consumer- and domestic-driven model, what China’s new president, Xi Jinping, refers to as the “Chinese dream.”     

Certainly, the flow of Chinese facts and figures confirms that a speculative fever has developed. Domestic credit creation, for example, has surged beyond anything required by even the most robust economic and business fundamentals. The latest figures show such credit creation up 52% during the first five months of this year from the comparable period in 2012.1 The PBC noted that in early June alone domestic credit increased by more than 1.0 trillion yuan ($163 billion), an amount, the bank noted, that has “never been seen in history.” What is more, much of this credit originated in short-term notes that are not counted on bank balance sheets and so sidestep Chinese regulatory structures. Much of this speculation clearly aims at residential properties. A survey of 100 Chinese cities shows home prices in June accelerated, rising an unsustainable 7.4% from June a year ago, up from 6.9% in May.   

At the same time, the all-important manufacturing sector keeps giving off signs of weakening. The usually reliable HSBC purchasing managers’ index dropped to a level of 48.2% in June, well below the 50% demarcation between growth and decline.2 New orders for industrial equipment and supplies declined as well, dashing hopes for a near-term pick up. Adding to the picture of manufacturing slack, Jiangnan Heavy Industries, a maker of steel structures for building and ships, recently reported falling orders and declining prices during the first half of 2013. Exports, faced with slow growth in the United States and outright recession in Europe, also have shown weakness. Against such a background, there is genuine concern that the real Chinese economy, which grew on average at a 7.6% annualized rate during the first half,3 might miss the official 7.5% government target for the year. It would be the first time since the 1998 Asian financial crisis that such a thing happened, and would go hard with perceptions of future possibilities, even if it did not constitute a hard landing.    

The PBC’s June efforts to serve both objectives were largely a disaster, if not an unmitigated one. They spoke to a measure of policy naiveté. After making clear to all lenders where the PBC wanted credit to go and where it did not want it to go, its governors wrongly expected immediate compliance. Lenders, however, were not quite so quick to follow orders. So, when policymakers provided what they believed was just enough credit to help sustain the real growth target, but deny funds to the speculative interests, it proved inadequate. Those on the speculative side continued their activities, while others followed the bidding of policymakers. The total demand, set against the PBC’s carefully calibrated supply, drove overnight lending rates up to alarming heights. In a matter of weeks, these rates rose from a relatively low level (for China) of 2.78%, to spikes at times approaching 30%.4

In the face of the sudden rate climb, Chinese stock prices collapsed, questions arose about whether the already weakened economy could survive, and, at the extreme, whether China was on the verge of a financial collapse akin to that faced by the United States in 2008–09. Many noted that a similar interest-rate spike preceded America’s collapse. Such easy parallels, however, revealed a different sort of naiveté among financial commentators. The problem in the United States, back in 2008–09, reflected a loss of confidence. Suspicions about every borrower’s ability to repay borrowings stopped credit flows, leading to the spike in rates. China, however, experienced something quite different: there was no loss of confidence.  On the contrary, all were eager to borrow and lend. China’s rate problems reflected a straightforward lack of liquidity, which is why, late in June, the PBC was able to ease the situation quickly and almost entirely simply by injecting more funds into the system.

The blunder of June—difficult and frightening as it was—will, however, not likely change China’s basic policy course. The lessons may make the PBC and other authorities adjust less precipitously than they had originally planned, but that is all. Beijing knows that it still needs to deflate the speculative bubble while at the same time sustain faltering growth. Stiffening Beijing’s commitment to such a duel strategy is the government’s fundamental decision to alter the basic orientation of China’s economy. The country’s leadership is well aware that the economy can no longer count exclusively on exports as its growth engine. Chinese government websites note how the country cannot repeat the stellar performance of the last 20 years, during which time Chinese product rose from a negligible portion of the world exports to more than 12%.5 This desire to shift to a consumption-based economy and one that gives equal weight to domestic development will take significant policy adjustment as well as a redirection of capital flows, which, as much as more immediate concerns, motivates Beijing’s mixed policy agenda.

Anticipating the strains of the situation, both its immediate aspect and the more fundamental needs, Beijing has talked down economic growth prospects. The official real growth target of 7.5%, accordingly, contrasts starkly to China’s historical double-digit annual real growth rates. Beijing knows that domestic development, by nature, will produce growth more gradually than the historical export-driven model did. More than just this bow to reality, the nation’s leadership, as Zane Brown has pointed out, has engaged in a typical and very practical political ploy. Rather than hype matters early on—as Beijing could do, and then face reality later—this new Chinese administration clearly has decided to talk down expectations now, to avoid any appearance of failure later, and also to raise the prospect of a pleasant surprise subsequently in the middle of its tenure. Accordingly, both President Jinping and Premier Keqiang have shown a remarkable tolerance for slower growth and a similarly remarkable reluctance to engage in the stimulus efforts that some China watchers, remembering the government spending surge in 2008, expected.

However difficult the policy path before Beijing is today, probabilities suggest that China will manage something close to the balance its leadership seeks. To begin with, the country’s real estate excesses, though dangerous, are unlikely to wreck the economy as real estate excesses did in the United States in 2008–09. For one thing, Chinese homebuyers are not nearly as leveraged as Americans were. In China, homebuyers must put down 20% on their first home and 50% on their second. The financial leverage lies with local and provincial governments, which, if distressing, is a known exposure, as a subprime mortgage was not, and much easier for the central government in Beijing to cope with than the subprime disaster was for Washington. What is more, China does have tremendous domestic development potential, enough to make the 7.5% growth target easily achievable for a time, even if exports remained constrained by slow global growth. Indeed, there are already signs that the basic reorientation may have gained traction. Though manufacturing has slowed and even declined by some measures, Chinese retail sales have continued strong, up 12.9% in May, in fact, from year-ago levels.6

More immediately, Beijing, as it showed in June, has the power to tailor liquidity flows to avoid economic upset. Perhaps even more significant, the PBC has much more power than, say, the U.S. Federal Reserve to direct credit flows, if not week by week, certainly quarter by quarter. After all, most of the large lenders are government owned. It is quite plausible, then, that over time policy can simply direct credit flows, as desired, away from speculative activities and toward longer-term development objectives. Of course, anything can happen. But against this array of considerations and options, China, if it is scheduled to grow at a slower pace than in the past and if it doubtless will continue to face rough patches, still looks likely to meet its growth targets and avoid a “hard” landing, no matter how skittish the media and global traders will occasionally become.


People’s Bank of China website.
2 See, for example, Simon Rabinovitch, “Anemic Manufacturing Data Raise China Growth Fears, Financial Times, July 1, 2013, and “Chinese Manufacturing Gauges Fall as Slowdown Persists,” Bloomberg Businessweek, July 1, 2013.
3 Lingling Wei and Bob Davis, “Inside China’s Bank-Rate Missteps,” The Wall Street Journal, July 2, 2013.
4 Bloomberg.
5 Ministry of Finance (China) website.
6 Michael Kitchen, “China’s Economy Slowing; Government May Not Care,” Market Watch, June 8, 2013

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