Speaking at the National People’s Congress in 2007, the then Chinese Premier Wen Jiabao declared, “The biggest problem with China’s economy is that growth is unstable, unbalanced, uncoordinated and unsustainable.”
The strategy outlined to deal with this challenge was to shift the economic growth model from being investment and export driven to consumption and domestic demand driven, with a parallel shift from manufacturing to services.
But then came the global financial and economic crisis later that year and China’s answer was a truly massive stimulus package of over $600 billion, according to some estimates. This took the form of abundant and cheap credit to mostly local government entities and State-owned enterprises (SOEs), which invested in more property, infrastructure and capacity expansion in manufacturing industries, taking the economy in a direction reverse of what the proposed reforms had intended. Quite predictably, the economy has ended up being more “unstable, unbalanced, uncoordinated and unsustainable”. This is most dramatically reflected in one single, telling figure: The credit overhang in the Chinese economy is now 250% of GDP and slated to rise to 300% by 2020. International ratings agencies have downgraded Chinese credit risk from stable to negative recently. While official figures put China’s current GDP growth rate at over 6.5%, some analysts believe it is closer to 5% or less. In order to prop up growth, a 4.6 trillion yuan additional credit has been pumped into the economy in the first quarter of this year, which will further exacerbate the problem of overcapacity and misallocated resources.
In order to reduce the risk from bad loans and non-performing assets with local governments, the Chinese government has allowed them to issue local bonds which can be used as collateral for bank loans. This merely shifts the financial liability on to banks, which are already over-leveraged. Similarly, SOEs are being permitted to convert part of their outstanding loans into equity. But banks will merely hold these as non-performing shares instead of as non-performing loans, and if the SOE’s fortunes continue to decline, then the banks will end up in a worse financial situation.
It has been argued that one part of China’s rebalancing strategy seems to be going well and that is easing pressure on domestic overcapacity through aggressive capital investment abroad. This is the apparent motivation behind the ambitious One Belt One Road (OBOR) initiative, for which a $40 billion fund has been created. However, recently a former senior Chinese finance official made the following revealing admission on a Chinese website, before it was taken down by internet censors: “In previous years, China made large investments in the energy sector. Looking at it now, these investments were useful in ensuring energy supplies though financial losses were large. If we do not go this route, external demand will shrink, which will put tremendous pressure on domestic production and exacerbate the overcapacity problem. So despite the difficulties we need to stick to this overseas economic strategy”.
What is clear from this overall picture is that China is not rebalancing its economy; in fact, it is repeatedly kicking the can down the road for fear of a hard landing. The longer this continues the greater the future risks to the Chinese economy and to the global economy, considering China’s status as the world’s second largest economy, its biggest trading nation and now a major capital exporter.
These uncertain economic dynamics are playing into the ongoing political uncertainty within the Chinese Communist party leadership. When Xi Jinping became the top party, State and military leader in 2012, he was presented as a pre-eminent leader in the mould of Deng Xiaoping, if not Mao, in a category above the other six members of the Communist Party Politburo Standing Committee, which is the highest forum of collective leadership. There was speculation that his elevated status was a consensus decision of the Party, designed to give him the authority to push through the urgent and overdue reforms, to finally enable the transition identified in 2007. The 60-point ambitious reform package announced at the third plenum of the 18th Party Central Committee in November 2013, seemed to confirm this. It was also assumed that these economic reforms would be accompanied by political reforms in the direction of greater individual freedoms, rule of law and enhanced role of the private sector. Even the anti-corruption campaign unleashed by Xi Jinping against both “tigers and flies” appeared to be an integral part of the same reform package. Two years later economic reforms have mostly stalled. Maintaining Party ascendancy has repeatedly trumped the logic of reform. We find Xi Jinping aspiring to an even more elevated, indeed, unassailable leadership position than at the beginning of his term. He is being described as the “core” of the party leadership and dissent within both the party and outside, is being vigorously and ruthlessly suppressed. The media is being brought back under strict party control. The anti-corruption campaign has morphed from being a genuine attempt to root out venality within the party to an instrument being wielded in factional struggles. There continues to be activism on the external front particularly in the South China Sea.
There is a link between the slowing and increasingly vulnerable economy and the revived political authoritarianism and nationalist pretensions of Xi. He may be justifying his exercise of untrammelled power as necessary to maintain party supremacy in the face of political and social tensions which a stalled economy is likely to unleash. But this is being challenged within the party and the army. There is real risk of political blowback.
The impact of these developments on the global economy and international security could be profound and enduring.
Shyam Saran, a former foreign secretary, is currently chairman, RIS and Senior Fellow, CPR
The views expressed are personal