China passed multiple economic hurdles in 2013, but there are more challenges to come. A sustainable debt-to-growth ratio will be the key issue to tackle in 2014.
China showed the world in 2013 that it would not let its slowing economy crash. Although the official data is not out yet, experts are mostly optimistic that China is going to meet its 7.5% GDP growth target.
Last year, China survived capital outflow, a liquidity crunch and a sluggish manufacturing sector. Surviving under these circumstances was some achievement by any standard. Unfortunately, these are now the sorts of things that China will have to deal with frequently in the years to come. The debates on whether or how China’s economy will land on its feet may continue in 2014.
In 2014, China’s economy is most likely to stay afloat with a GDP growth rate around the government’s target, which is rumored to be 7% this year. There are two reasons for that. First, China’s major economic indexes are looking good, with an unemployment rate of 4%, a mild CPI of 2.5% and GDP growth of 7.8% in the third quarter of 2013. Second, the government is trying its best to meet its GDP expectations, against all odds. In August 2013, a mini-stimulus was launched to boost the country’s output, after slowed GDP growth had been reported.
In the long term, however, things get harder to predict. One uncertainty is whether China’s mounting domestic debts are sustainable. Another is whether the slowing GDP growth, which is consistent with the government’s plan to curb the economy’s reliance on investment and manufacturing, will plunge too far and become a burden to outstanding domestic debts.
David Levy’s metaphor for China’s future risks is vivid: “In recent years, a couple of engines have not been working well, and the pilot is now loath to keep straining the remaining good engines. He is allowing the plane to slow down, but if it slows too much, it will fall below stall speed and drop out of the sky.”
Domestic debt in China has skyrocketed to over 200% of GDP since 2008, and may reach 271% of GDP by 2017. Local government borrowings have contributed to part of that, reaching $2.95 trillion in late 2013, about 40% of China’s GDP. A recent Moody’s report put it bluntly that the local government debt is serviceable only if China’s GDP grows at around 7% over the next 5 years.
Meanwhile, China’s private debt to GDP reached 160%, according to The Financial Times. Worse still, the investments made today become less efficient, causing excess capacities in many industries (see Chart 1). Low returns on investment make it harder to service domestic debt. Francis Cheung at CLSA reckoned that the Chinese manufacturing industry needed to shut down capacity and write off investments worth RMB 1.5 trillion, which would double the banking sector’s bad loan ratio.
The Chinese leadership has already realized the potential risks and attended to that problem. A soft landing is likely when the government starts to allow loan rescheduling during liquidity crunches, or simply uses monetary easing to help borrowers get by. Leniency towards borrowers may prevent a chain of defaults and stabilize the economy. However, this is not entirely compatible with China’s goal of transforming its economy to a consumption-based one. A prolonged soft landing process could still be followed by a hard crash, if not properly managed.