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The reality is that China is bracing herself for gigantic bubbles and headwinds, both within the country and without.

Slowing Dragon, Worrisome for world!

Global GDP growth is unlikely to rebound significantly in the next two years, as a gradual slowdown in the Chinese economy and structural impediments in the euro area, Brazil and South Africa continue to weigh on economic activity. We expect robust growth from UK and India as well over the next two years, adding to the US-led positives.

- Moody’s

INTERNATIONAL ECONOMY CHINA

BY ANDREW K P LEUNG, SBS, FRSAInternational and Independent China Specialist. Chairman, Andrew Leung International Consultants Limitedwww.andrewleunginternationalconsultants.com

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An unexpected fall in new yuan loans in December was a clear sign of sluggish demand as China’s

manufacturing sector faced deflation for 34 months in a row. The main worries are how far signs of China’s slowing economy may persist, how serious are her housing and credit bubbles, how much could they un-dermine the country’s stability, and what are their impact on the rest of the world. The People Bank of China, the country’s central bank, cut inter-est rates for the first time in two years in November, while also loosening a rule that restricted banks’ loanable funds. On 15th January, it raised the quota of relending by 50 billion yuan ($8.12 billion) to help financial institutions extend loans to rural and small businesses. The National Development Reform Commission (NDRC) has reportedly approved trillions of yuan worth of projects for 2015. These are part of the ongoing infrastructural investments to spur the nation’s breathless urbanization.

In an annual review on 15th January 2015, Zhu Zhixin, NDRC vice-minis-ter, revealed that China’s economy grew 7.4 per cent in 2014, somewhat below target. He expects that eco-nomic restructuring will continue this year and if risks appear, the authorities will take decisive action to keep it on track. PBOC made it known on 14th January that its mon-etary policy would stay prudent and “appropriate”, neither too tight nor too loose. China has refrained from any strong credit stimulus to spur growth, under what is dubbed a “new normal” for the economy.

Is it the ‘New Normal’? In a speech on 9th November to CEO’s at the APEC Summit in Bei-jing, President Xi clarified what he meant by the “New Normal” in

China’s development trajectory. It’s no surprise that a large economy like China’s cannot be expected to grow at near double digits indefinitely. So a slower and more sustainable rate of growth is only to be expected. Nev-ertheless, China cannot slow down too drastically if the country’s mas-sive surplus labour is to be gainfully employed.

President Xi explains that on bal-ance, this new paradigm means per-manent change from high-speed to moderately high-speed economic growth and continuous economic re-structuring. Services and consumer demand will gradually become the mainstay of the economy; regional differences will continue to be nar-rowed; household income will con-tinue to rise as a proportion of the economy; and a greater sharing of the fruits of economic development amongst the masses. Above all, it implies a fundamental shift of the nation’s economic direction from export-predominance to achieving more balance with domestic con-sumption and from investment-driv-en to innovation-driven. President Xi emphasized that even at around 7 per cent average annual growth, China’s economy will still be leading the world. However, it is the qual-ity of growth that is being focused. Growth in future will be more stable and multi-dimensional with a new set of “four modernizations” - New industrialization, Digitization, Ur-banization, and Agricultural mod-ernization. Greater reliance will be placed on domestic consumption to grow a more balanced economy less vulnerable to external risks.

Characteristics of economic re-structuring have already manifested themselves in the first three quarters of 2014. Consumption has overtaken investment as the main contributor to GDP growth. The share of services at

46.7 per cent of the economy has sur-passed the share of manufacturing. High and new technologies, includ-ing machinery manufacturing, have registered higher rates of growth than the industrial average. Govern-ment streamlining and de-regulation have resulted in greater market vital-ity with newly-registered enterprises growing at 60 per cent over the pre-vious year.

According to President Xi, in adapt-ing to the “New Normal”, the coun-try will remain vigilant of new con-tradictions and hidden risks. Overall reform deepening will be intensified to energize market vitality;to widen paths for innovation; to push for-ward high-quality “outward open-ness”; and to promote people’s well-being, including equality and social justice.

That, people may say, is the rheto-ric. The reality is that China is brac-ing herself for gigantic bubbles and headwinds, both within the country and without.

Property Bubble Whether China’s property market is heading towards collapse is ex-amined in a policy brief dated Au-gust 2014 by Li-Gang Liu, visiting fellow at the Petersen Institute for International Economics, Washing-ton DC. While noting that China’s housing market is spluttering, the research paper explains that any comparison with Dubai or Japan is wide off the mark. This is because China’s housing market did not exist before 1998. Formerly, all housing-was government-owned. Following liberalization, the market remains characterized by massive demand from China’s mounting middle class. Mortgage gearing has stayed very low with down payments of at least 30 per cent or higher. With some ex-ceptions, current affordability ratios generally remain at reasonably com-

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fortable levels in many cities as both rural and urban incomes have great-ly increased in recent decades.

It is true that speculation is still rife and many properties remain empty at present. The government has been active in clamping down speculation with a raft of monetary and admin-istrative measures. The situation is likely to improve significantly over time because China is undergoing the fastest and most extensive urban-ization transformation in human his-tory. Over 200 million more people are moving from the villages to cit-ies by 2023. Game-changing reforms have been launched at the Party’s Third Plenum in 2013. These will confer urban household registration (hukou) on rural migrants, entitling them to basic social provisions in-cluding healthcare and children’s education. Peasants are now permit-ted to lease or mortgage their land.

This will provide them with financial resources to establish homes in ur-ban areas. The transformation pro-cess will take some time and images of new ghost towns and shopping malls may recur. But let’s not forget that on a much smaller scale, there

were similar images when Shenzhen and Putong (in Shanghai) were first built rapidly over paddy fields.

According to Mizuho Securities on 14th January 2015, “land price in all tier-1 cities would continue to grow, very likely at a faster pace than last year”. With stringent government diktats against speculation, this is a signal that investors begin to see an upside in a better regulated housing market.

Financial BubbleAdmittedly, China’s capital utili-zation is extremely inefficient and wasteful. More and more capital is required to generate an extra unit in-crease in GDP growth. According to The Economist (29 September, 2012), overall debt is approaching some 277 per cent of GDP, with corporate debt accounting for 103 per cent, govern-ment debt at 89 per cent, financial debt at 60 per cent and consumer debt at 25 per cent.

However, according to Standard Chartered Bank, China’s total debt to GDP ratio ranks midway in a list of 17 countries, way below that of Japan and the United States. Unlike West-ern countries, consumer credit rep-resents a small fraction of total debt. Public debt only represents some 82 per cent of GDP with 27 per cent ac-counted for by local government debt and another 7 per cent representing off-balance-sheet “local government financing vehicles (LGFVs)”.

Bigger but slower - China’s GDP growth since 1992

Slowing DownThe IMF forecast that China’s

inflation-adjusted GDP will continue to slow over the rest of the decade^

^Assumes no change in exchange rate and a continuation of current policy plans

Source: IMF

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Nevertheless, shadow banking is on the rise in the form of unrealisti-cally high-yield wealth management products and trust companies. How-ever, as a percentage of GDP, shad-ow banking only represents about 28 per cent of the regulated banking sector, compared with 200 per cent in the US, according to the Wall Street Journal. In shadow banking, China ranks 12th in the world amongst a list of 27 countries, better than the UK and Canada but worse than Aus-tralia, Germany and France, accord-ing to the Financial Stability Board (FSB) and J P Morgan. In any event, Beijing is watching the vulnerability of China’s financial system with an eagle eye. With $3.9 trillion of foreign currency reserve, China is relatively well positioned to keep her financial system on an even keel, come what may.

Headwinds and Tailwinds!Indeed, storm clouds are gathering in the horizon for a perfect storm of global proportions. Just as the rest of the world will be severely impacted if China ever slips into financial tur-moil, China’s resilience will be test-ed if she is hit by a perfect financial storm coming from all sides. Nev-ertheless, some of these clouds may have a silver lining.

First is the deleveraging of history’s largest debt bubble – that of the United States. This consists of $19.8 trillion government debt, 39.4 tril-lion private debt, $2.3 trillion foreign debt and $66 trillion unfunded en-titlements. All told, they come to 8.2 times America’s GDP. This mountain of debt has been built up over the years with successive Quantitative Easing (QEs) or money-printing, sup-ported by close-to-zero interest rates. Should the Fed raises rates even by a little, the interlocking debts, some internationally connected, are likely to face shocks which may topple the whole sand castle (Endgame - Maud-lin and Tepper, 2011). If this happens, even more so than the last global fi-nancial crisis, no country, including China, could be totally immune. This is because as the world’s predomi-nant economy, the United States is closely linked to the rest of the world, not least in dollar-dominated financial instruments. Second is the global asset bubble. Much of the tsunami of money-print-ing liquidity has found its way into emerging markets, including China, seeking higher returns. This has be-ing driving up asset prices includ-ing stock markets and properties. A reversal of the flood is bound to

send tremors across many sectors and economies linked to the global banking, financing and investment systems.

Third is demographics. While con-traction due to deleveraging is hap-pening in many parts of the world, this coincides with a looming “de-mographic cliff” in the world’s ma-ture economies as baby boomers retire and tighten their belts in the United States, Europe and Japan. Even Germany is slowing down as aging demographics are beginning to hit home. This contraction would be bad news for China, still depen-dent on exports to large Western markets for generating sufficient jobs for her teeming millions. Moreover, China’s own population is also ag-ing rapidly with a dwindling labour pool. While China has found it time-ly to liberalize her decades-old One Child Policy, the situation is unlikely to change dramatically in the near to median term.

Fourth is the bursting energy bubble. Oil prices are collapsing, dropping 55 per cent since July 2014 to below $48 a barrel. While the US economy is set for a rebound driven in part by the so-called “shale gas revolu-tion”, much of the drilling is being

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financed by “high yield” or “junk” bonds. Plummeting gas prices across the globe and the risk of a Fed inter-est rate rise are beginning to unravel some of the initial shale-revolution hype. Nevertheless, cheaper energy prices should be good news for con-sumers and businesses worldwide except energy producers. However, there is massive oversupply coupled withless robust demand growth due to economic restructuring of some of the world’s major energy consumers, especially China. A global market shakeout seems inevitable with geo-political implications for main ener-gy producers such as the Middle East and Russia. However, low energy prices are bound to benefit China’s economy, the world’s largest energy consumer par excellence, and will give China even greater leverage in coming energy deals at the corporate and national levels across the globe.

All in all, 2015 and the coming years are likely to be a turbulent period for China. The country is undergoing epochal economic and social trans-formation at a time of rising domestic aspirations, changing demographics and global headwinds. A slower and hopefully more sustainable growth model will become China’s “New

Normal”.

China’s timely New Silk Road Strategy China appears on cue to seize the moment to launch a 21st Century New Silk Road Strategy. This is likely to act as a cushion against the coming shock waves. The mind-boggling infrastructural blueprint consists of a “Maritime Silk Road” linking Fuzhou on China’s east coast, through Malaysia, Indonesia, to Ke-nya, and traversing the Red Sea, to Athens, ending in Venice. This in turn is to be linked by an overland “Silk Road Economic Belt” to Duis-

burg in Germany, through Moscow, Turkey, Iran, Kyrgyzstan, onwards to China’s Urumqi, then all the way to Xi’an.

The blueprint is supported by Presi-dent Xi’s launch at the recent Octo-ber/November APEC meetings in Beijing of an Asian Infrastructural Investment Bank (AIIB), to which China is pledging $50 billion towards half of the initial capital. 21 countries in the region have already signed an accord in support. It is further but-tressed by China’s proposed Free Trade Area for the Asia-Pacific (FTA-AP) and a Silk Road Infrastructural Fund of $40 billion, which will ben-efit 30 countries of 3.8 billion people overland from Europe to Asia.

China’s epochal Silk Road strat-egy with the FTAAP is designed to counterbalance the dominance of the United States in global affairs, par-ticularly in the Asia-Pacific, charac-terised by the US Pivot to Asia and a Trans-Pacific Partnership (TPP) excluding China. How China man-ages to realize her ambitious Silk Road vision will define if and how a “New Asia-Pacific Century” is to take shape.

In the final analysis, with the loom-ing economic uncertainties across the globe, this New Silk Road blueprint may yet be able to offer some light while the world is to pass through a potentially long and dark tunnel.

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