Ten years ago, the Chinese government dropped a massive stimulus package to revive its economy in the aftermath of the financial crisis. Prior to, China was responsible for about 6 percent of the world’s GDP. Today, it contributes close to 19 percent, adjusted for purchasing power parity. To sustain this recovery, China also dropped a massive debt bomb on itself, and some experts think it’s about to explode. China’s economy is slowing down, and it simply can’t afford another stimulus package. Debt is at 250 percent of GDP (roughly $34 trillion) and officials are palpably worried because much of the debt originated in the unregulated shadow banking system. Of key importance is whether China can defuse its debt bomb without intensifying its economic slowdown, and everyone should care because China has been driving global growth.
As China recovered from the crisis with its extremely loose monetary policy, its economy grew on the backs of onshore Chinese companies that leveraged themselves with enormous amounts of U.S. dollar debt. Over the last year, on the back of slower consumption, the dollar-yuan exchange rate flew through the roof (exacerbated by trade war concerns and emerging market weakness). This means that companies are selling less while having to pay back maturing debt that is now more expensive – and there’s a ton of it maturing at the end of this year and early next year, $55 billion to be exact. This is almost four times the amount of Chinese developers’ offshore borrowing of $14.5 billion, coming due at the same time.
And so, while the government has been busy tightening policy over the last few years to deleverage the economy, a slowdown has kicked them back into easing mode. While an optimist might posit that it’s a manageable derivative of a booming economy and that China can grow its way out by increasing inflation, a pessimist would argue that it’s not self-correcting. It’s generally hard to rely on increasing inflation to outgrow debt because a core component is credit growth, which is characteristically hard to stimulate. Moreover, companies are so heavily indebted that it’s unrealistic to promote credit growth. While the government has expanded media censorship beyond politics into economics, economic indicators can reveal what the government won’t.
Quarterly GDP growth has slowed while a slight uptick in manufacturing production indicates that factory output has begun to increase. A reading above 50 indicates expansion, a reading below indicates contraction. However, new orders in China decreased to 50.8 index points in October from 52 index points in September. According to Trading Economics, new orders in China averaged 53.63 Index points from 2005 to 2018. New export orders also decreased from September to October. Altogether, this suggests an outlook less rosy than production output would suggest.
Typically, consumer confidence decreases when an economy is contracting. It is often a lagging indicator of stock market performance. The CSI 300 index, which replicates the performance of the top 300 stocks in the Shanghai and Shenzhen stock exchanges, has substantially underperformed developed markets over the last 12 months, as well as emerging markets that have been experiencing economic turmoil. While consumer confidence remained unchanged at 118.5 index points from September, the downtrend indicates that consumers are uninclined to assume the economic burden from the U.S.-China trade war. The government appears to be losing its soft-power over consumers.
Declining growth in October real estate construction starts and residential property sales could also indicate economic contraction. Developers are struggling to repay existing dollar denominated debt as credit growth has slowed, and the slowdown coupled with a depreciating exchange rate isn’t helping. If developers want to reissue debt, it’s going to be more expensive, not just because of rising global interest rates, but also because China’s economic outlook is weaker than when developers last issued debt. When the Chinese government is in fiscal trouble, it starts spending to increase industrial production data. It starts building bridges to nowhere and constructing buildings for nobody in particular – just take a look at the widening gap between construction starts and sales.
Investment in fixed assets and industry output stabilized from a downward trend while investment in fixed assets increased steadily since August, tentatively indicating signs of stabilization in October. This was likely underpinned by government action as consistently weakening retail sales have created strong downward pressure on output.
Economic data indicate that China is struggling to stimulate growth. Its economy is growing at its slowest pace since 2009, and consumers are unwilling to assume the burden from the trade war. As public and private enterprises struggle with the cash crunch, businesses won’t survive for long without access to credit, no matter how much government support they have.