China’s economy is at its weakest in decades. Every observer seems to be anticipating an economic stimulus plan from Beijing. But I believe China should try deregulation and supply-side solutions for a change.
Economic stimulus is well-suited to addressing the cyclical weakness of the economy. But China’s downturn today is also structural in nature. And China has very limited scope for further economic stimulus, having offered that for over four decades.
First, while the central government budget deficit is still modest, regional governments are buried in debt. And some regional governments are already on the cusp of default.
Massively expanding fiscal spending to build more infrastructure has become an unattractive idea, even to Beijing’s bureaucrats. They are still confronting the diminishing returns of such infrastructure projects, including the white elephant projects across the country.
Some analysts argue that regional governments still have vast assets (such as banks, real estate, and water and electric utilities) to support their continued fiscal expansion in infrastructure building. But most of these assets have been pledged to support their financing vehicles in recent years. Given their heavy and rapidly growing debt loads, one wonders just how much borrowing capacity Chinese regional governments have left at all.
Are they likely to privatise their asset holdings to finance more infrastructure building? There are two hurdles here. For a start, political will is lacking. Regional governments seem determined to secure handouts from the central government.
Workers at a construction site in Huai’an city, Jiangsu province, on July 8. Photo: Getty Images
Also, while selling asset holdings may provide a short-term solution to the debt problems of regional governments, it will undermine their future revenue streams. As their revenues from land sales have permanently declined, their reliance on banks and utilities has grown substantially.
It is true the central government has the capacity to vastly expand spending to stimulate the economy. But that would rely on massive deficit financing and thus requires an ideological shift.
Spending huge sums to bail out indebted regional governments is inevitable in the next few years, but Beijing will do so very reluctantly because the demarcation of fiscal budgets between layers of government is meant to impose discipline on regional governments – bailouts from Beijing weaken that discipline.
Secondly, monetary policy solutions have become ineffective as interest rates are already very low, with very little scope for further reductions. At the current 4-5 per cent, lending rates are barely enough to cover banks’ operating costs, let alone bad debts, and call into question the profitability of the banking sector.
As countries in the West raise their interest rates to combat inflation, China has had to watch out for its exchange rates, especially if it were to cut interest rates by much more. That’s why when the People’s Bank of China reduced interest rates recently, it did so by a mere tenth of a percentage point.
What about lowering banks’ reserve requirement ratios? But there are also hurdles with that option. The idea of a lower reserve requirement ratio is to allow banks to lend more. But rapid credit expansion has gone on for too long, and the whole business sector is already heavily in debt.
Businessmen there have limited appetite to borrow more as their investment outlook is poor. Indeed, many businesses and households are deleveraging. Bad debts are mounting, but bad debt resolutions also involve challenges, such as local governments’ interventions and labour market implications.
All said, China’s monetary conditions have been loose and accommodating. For example, the broad money supply (M2) has been growing at 10-11 per cent year on year in recent months, similar to over the past few years, and substantially higher than the nominal gross domestic product growth of 6-7 per cent of recent years past. In other words, the weakness of the economy cannot be blamed on credit conditions.
Many observers call for aggressive government help to resuscitate the property sector as a way to rescue the economy. But that’s ill-advised, in my view. Few would dispute that the property sector is massively overbuilt. Building more is a bad idea. Lower property prices are exactly what the government has been trying to achieve over the past decade. Moreover, the core problem faced by property developers is that sales are sluggish.
Even if the government were to rescue the sector, there is no mechanism to do so. What would be the option? Is it to give property developers cash grants? But who should receive grants and how much? Is this politically acceptable? Or is it to extend more credit? But they are already soaked in debt! Ultimately, property sales have to pick up. But here, there is nothing the government can, nor should, do.
To boost the economy, however, there is a lot the government can do, particularly in deregulation. For example, in the big cities, there are still restrictions on property prices, hukou controls (over household registration, and therefore residence) and homebuyer eligibility requirements.
All these should be removed. In the broader economy, onerous licence requirements and time-consuming project approvals should be cut down. Tax burdens should be reduced. And random inspections of businesses and arbitrary punishments should be curtailed.
Fiscal stimulus can provide a quick, superficial and wasteful fix for a sick economy. But deregulation and supply-side solutions are more equitable and, therefore, more sustainable as small businesses will be able to participate in the subsequent economic revival.
Joe Zhang is co-chairman of SBI China Capital, and author of “Inside China’s Shadow Banking: The Next Subprime Crisis?”
