Sunday, December 25, 2011

China's Growth Model Tests Its Limits

The IMF said outstanding loans have increased by almost 100pc of GDP over the last five years, roughly double the intensity of the credit boom in Japan before the Nikkei bubble burst or in the US after the subprime housing bubble burst. The boom has pushed house price-to-income ratios to 19 in Beijing, and 15 in Shanghai and other eastern cities.

This has become a threat to social stability. Poorer Chinese can no longer afford to buy or rent property. The government is rushing through plans to build 36m homes for low-income families at a cost of $850bn, but it is not yet clear where the money will come from.

Professor Victor Shih from Northwestern University said the government implicit’s debt is near 100pc of GDP when hidden borrowing by local authorities is included. It is questionable whether the banking system can easily pump up the economy again, even if ordered to do so.

Fitch Ratings warns that there has already been a "massive build-up in leverage", eroding the ability of lenders to generate genuine economic growth by expanding credit. The IMF says banks could be "severely impacted" if the soft-landing turns hard. The receding tide this year is likely to reveal whether or not banks are bathing naked.

Capital is already leaving the country. China’s $3.2 trillion foreign reserves have begun to shrink. Officials in Beijing have warmed of a "grim" year to come, muttering about the possible need for a weaker yuan. Any such currency move would set off a storm in Washington, risking a trade war.

The Politburo knows that China’s growth model has hit its limits, with over-reliance on exports. Investment is running at 46pc of GDP and the national savings rate is 54pc, both signs of a massively distorted economy.

The great task is to unleash consumption, and that in turn will require a cultural revolution. Not much happened on this front in 2011. Perhaps 2012 will show a flicker of movement.

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