THE RECENT steep slides on global stock markets have been a
long time in the making. As early as two years ago, it was becoming
obvious that in addition to the contraction of global demand, as well as
the general increase in the relative competitiveness of other Asian
countries, China’s rapid rise was coming to a screeching halt and
leaving excessive debt in its wake.
In recent weeks, the Chinese market experienced its biggest
weekly fall in 20 years, tumbling more than 15%. This volatility serves
as a further warning: China is still an emerging market, and it has an
immature financial system.
EXCESSIVE DEBT Excessive debt is infecting every sector of
China’s economy, from real estate and local governments to state-run or
partially government-controlled companies.
Most large companies in China were on a roll for a number of years, in
large part thanks to subsidies from the government. But, at the same
time, they were not accruing capital because their activities were so
dependent on subsidies. Chinese banks, which are mainly controlled by
the Communist party, compounded matters by giving credit at artificially
low interest rates fueling excessive debt in all of the country’s
Many of China’s big-ticket development projects are perfect examples of
how excessive debt has piled up. Infrastructure projects, funded by
subsidized loans with low interest rates, yield low profitability and
weak capital productivity. Much of this credit is given through a system
called “shadow banking,” meaning it does not go through normal bank
loans; credit products are sold directly to individuals.
Public sector debt, particularly at the local and regional levels, has
been enormous. They have gotten in their current predicament by
over-relying on infrastructure projects. This cannot last forever as
there are only so many roads one can build.
DEMOGRAPHY AND ENVIRONMENT WOES China also has a number of
other problems on top of its high level of debt and low capital
productivity. Due to the one child policy being in place for so long,
its massive elderly population will have to be sustained by a much
smaller working population. Social spending by the state will only
increase exponentially, especially on education and health. The Chinese
government also has a very high budget deficit. It is officially
estimated to be at 3% or more in 2016, but how high it will really climb
is anyone’s guess.
Last but not least, the country’s environmental problems are a
well-known major burden to China and the rest of the world. Anyone who’s
ever been to or seen pictures from Beijing is familiar with the city’s
residents making their way around the city in anti-pollution masks.
Chinese authorities face some very tough choices ahead. China is
currently exhibiting many “rich country” problems while it has the
budget of a “poor country.”
A structural reform of its tax system is now clearly needed; its current
system is archaic and biased. No country can have its cake and eat it
If China wants a market economy, then it must understand that
intervening in markets is bound to fail, and it must learn to accept the
volatility that comes with any open market economy. The volatility we
are currently experiencing in the markets only confirms what many
already know: Beijing doesn’t have that much control over the economy
In the coming years, China will most likely go through a very similar
scenario as Europe has in the years after financial crisis. Serious
restructuring in Chinese business models and banks’ balance sheets. This
does not mean that the Chinese economy will collapse. Far from it. We
will see much lower growth rates, but there will still be growth.
CONTAINED EFFECTS China’s sheer size and role on the global
stage means that its problems will create risk for the global economy.
However, don’t expect a crisis of 2008-2009 proportions. Any damage
China will cause will be relatively contained. Some countries that might
have to worry are those that export raw materials or luxury goods, and
on a smaller scale, the Euro zone.
Nuno Fernandes is Professor of Finance at IMD, where he directs the
Strategic Finance program and also Finance Fundamentals for Executives, a
new IMD “Global Leadership in the Cloud” program. He is the author of
Finance for Executives: A Practical Guide for Managers.
ROLAND SAN JUAN was a researcher, management consultant, inventor, a part time radio broadcaster and a publishing director. He died last November 25, 2008 after suffering a stroke. His staff will continue his unfinished work to inform the world of the untold truths. Please read Erick San Juan's articles at: ericksanjuan.blogspot.com This blog is dedicated to the late Max Soliven, a FILIPINO PATRIOT.
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