Thursday, 4 July 2013

China struggles with a boom and bust cycle

Large Chinese goods producers slowed to multi-month lows as global demand weakened at the end of the second quarter of 2013. Coupled with this, the latest figures from Beijing saw China’s GDP grow by only 7.7 percent in the first quarter of 2013, down from an already subpar 7.9 percent in the fourth quarter of 2012.

A significant slowdown in China would be more catastrophic for Beijing than it might be for other governments. But while the signs for a slowdown are growing, a meltdown is still unlikely.

Last week, the interbank lending rate in China spooked global financial markets as it jumped sharply.

The debt lent to state owned enterprises and for infrastructure ventures, accumulated by Chinese banks for years, might now be bubbling over into a credit crunch. Chinese money markets also screeched to a near halt worrying people with access to China’s markets, which is almost everybody.

The central bank is trying to shift China’s financial structure from a debt-driven economy to a profit-driven economy. The skyrocketing lending rate has since dropped from its recent high in mid June, but it is still higher than Beijing’s ideal.

All countries go through natural boom and bust cycles. Companies go out of business and credit dries up while social anxiety mounts as unemployment rises.

Often the downturn is short as uncompetitive companies drop out of the market and larger corporations soak up a greater share of consumers. But sometimes the cycle can be protracted and usher deep structural and sometimes even political changes. It is not yet clear which breed of cycle China is facing.

Slower growth will pose an existential problem for the Chinese Communist Party. Their legitimacy and social contract with the Chinese populace rests on nearly full employment.

Many times in China’s deep past a lack of prosperity compelled the inner agricultural regions to force governmental change. Dynasties have fallen more often at the hands, shovels, and pickaxes of China’s own people than from the weapons of outside forces.

Ever since the end of the Maoist era in 1978, economic development has been priority number one for the party. To address the present downturn, the Chinese government is already extending liquidity as much as possible to cushion the impact of mounting financial challenges.

Beijing stands to retain widespread employment for the population, but at the same time they risk absorbing bad loans from poorly performing corporations and small businesses. Such loans have the potential to force more financial problems in the future, but Beijing really has little choice.

Borrowing money is expensive and can’t continue for long stretches without undermining the very reason it was employed in the first place. And growth in the past several years has been increasingly driven by the financial sector rather than the real sector of trade in goods and services.

But it is easy to predict collapse, and in some circles collapse in China is unabashedly desired.
At this point, the Chinese economy is far from out of the woods and their growth target appears to be under threat. Yet while a slowdown to less than 8 or 10 percent growth year-on-year will be a significant headache for Beijing, a true collapse to 2 or 3 percent growth is highly unlikely.

This is because many of the businesses receiving financial aid are still productive on relative terms and contributing to the economy.

Many other economies around the world are doing far worse than China, and even with its drop in growth so far this year, some independent forecasting boards suggest the country can still expect to grow around 7.5 percent in 2013. Compared to India and Brazil, both expected to grow by less than 5 percent this year, this is still quite a high growth expectation for China.

Also, as Joshua Kurlantzick says at Bloomberg Businessweek, China’s currency is still relatively controlled and its stock markets are not that large. Dire economic news might not encourage “the kind of runs on the Chinese yuan and Chinese exchanges that damaged such countries as Thailand in the Asian financial crisis”.

But the fluctuating lending rates seen recently are the result of a profound weakness in China’s financial sector. Without the cheap lending rates which Chinese businesses have become used to, bankruptcies could further destabilise already jittery markets and may cause cascading chain reactions throughout China’s banking system.

As credit becomes more expensive, companies will find it more difficult to stay afloat and its employees could find themselves without jobs. Beijing needs desperately to avoid the kind of social dangers associated with unemployment.

There remains a potential for China to tumble on the bumpy road ahead. However, if China’s central banking system can continue to resist the temptation to feed more cash into the economy to control lending rates, China might be able to weather the approaching boom and bust storm.

For many reasons, Chinese policy is cyclical and major companies will not be allowed to fail as long as Beijing clings to even a fraction of central control. The question is: can China’s ruling party survive the present unfolding boom and bust cycle?

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