By He Qinglian on April 25, 2014
Source article in Chinese: 微刺激：经济泡沫与投机继续膨胀
The recent emergence of the term “micro-stimulus” in the realm of Chinese economy marked the abandonment of the “no stimulus” directive of Likonomics”.
Reversion to “government stimulus”, why?
Back in early February this year, there were already signs that China's economic policy would return to the old way of government stimulus. But since one of the core ideas of Likonomics was “no stimulus”, such a change in economic policy became unspeakable, or it would at least have to be expressed in a different way. Hence: “micro-stimulus”.
Although it is true that Premier Li Keqiang did not want to walk the old and problem-laden path of government stimulus, the Chinese economy has come to be “dependent on government investment”. To change this feature of the Chinese economy is as difficult as making a heavy addict of amphetamine to quit using that drug. In my article published in July last year, I already expressed my doubts.
In February this year, the People's Bank of China (PBOC) announced its plan to hire Ma Jun as the chief economist of its research department. The ballooning of China's local debts to astronomical levels in the past several years worried many, yet Ma was among the few optimists who believed the scale of local debts was by and large manageable. Thus, Ma being appointed by the PBOC indicated the government would adopt a monetary easing policy.
Ma’s proposal to solving the problem of accumulated debts is to speed up the introduction of the regulation of local government bond issuance and, at the same time, local governments would continue to issue bonds. The scale of local government bond issuance has to be raised from 350 billion yuan in 2013 to above 500 billion yuan in 2014. While attending an international finance meeting in April, Deputy Financial Minister Zhu Guangyao announced in an interview that relevant laws would be enacted to give greater budgetary freedom to local governments that are immersed in debts.
Such an adjustment to economic policy was made due to the dire economic situation in China. Since the end of last year, there has been a string of crises in the trust business of the shadow banking system and bad news about private lending; there were a great number of small and medium enterprises going bankrupt due to a rupture in their capital chain; and the conditions of real economy was not good either. In March, the nationwide revenue stood at 1.01 trillion yuan, which increased 5.2% year-on-year; corporate income tax was 88.1 billion yuan, marking a decrease of 7% year-on-year; the tax revenue from industry and business fell by 28.8% year-on-year. Local finance remains highly dependent on land auction: in the first quarter, the volume of land premium was 1.08 trillion yuan, a year-on-year increase of 40.3%; and local revenue stood at 1.95 trillion yuan. The ratio between land auction income and other local revenue was 1:1.7.
From these figures we could see that if local governments in China had difficulty deciding whether they should inject stimulus to the economy before the first quarter this year, they now see such as necessary measures for them to try to avert the looming recession, even though they don’t know for sure if stimulus would work.
Micro-stimulus: the long awaited relief for local governments
Against the backdrop of a slowdown in economic growth rate becoming increasingly likely, the “micro-stimulus” scheme was unveiled. The regular meeting of the State Council convened in early April made clear three measures to boost the economy: to implement developmental financial policies and support rebuilding of shantytowns; to deepen systemic reform in railway investment and its finance and accelerate construction of railways; to study the possibility of an expansion in the implementation scope of tax rebates policies for big, small and micro enterprises.
International investment banks unanimously cheered these measures as they believed “micro-stimulus” to have an advantage over “large scale stimulus”: these measures to stabilize and increase growth are smaller in scale, amounting to merely 0.21% of China’s GDP and they would not result in new overcapacity or trigger new local government debts problems or cause prices to rise.
The way these banks reacted was driven by the interest of their own industry: their business could boom only when China remains a place of high returns for investment.
Local governments responded actively to the “micro-stimulus” measures unveiled by the central government and they put forward local version of measures to stabilize and boost growth. According to reports, provinces like Guangdong, Hainan, Tianjin, Jiangxi and Guizhou disclosed their key investment plans for this year, involving 3,665.8 billion yuan, 1,795 billion yuan, 823.1 billion yuan, 600 billion yuan and 249.9 billion yuan respectively. With the total amount of investment these provinces committed exceeding 7 trillion yuan and environment protection and transport becoming the focus of new projects, the directive that [local governments] should work to control and avert the risk of debts in 2014 has ceased to be effective.
While the concrete details with regard to the environment projects of these provinces are yet to be seen, the construction of transport system and new towns has been the center of economic plans of local governments and their details are readily available. Take for example the railway system; it is uncertain that the construction of railway could really generate economic benefits. The best evidence of this is that while the China Railway Group Limited has accumulated more than 3 trillion yuan of debts in total, many provinces include railway construction projects in their measures to stimulate the local economy. The first batch of key projects of Jiangxi province included 43 items relating to construction of transport system. Within this year, five highways are scheduled to complete, six existing highways will have their extension built; construction projects of thirteen new highways would commence; and the building of the Jiangxi section of four railways are expected to finish—these projects sound similar to a Great Leap Forward to me.
The construction of new towns in those provinces is not a reason to feel optimistic either. In 2013, the Task Force from NDRC's Center for Development and Reform of Cities and Small Towns conducted a survey in 156 prefecture-level cities and 161 county-level cities across 12 provinces and regions. The Task Force found that over 90% of prefecture-level cities had plans to build new towns and new districts. Altogether the capital cities of the 12 provinces and regions prepared to construct 55 new towns and districts. The craziest example was that a provincial capital in western China proposed to build three new districts and five new towns, which combined total size would be 7.8 times larger than the existing urban area of that city.
In view of ghost towns popping up all across China, one could see that the so-called new urbanization projects unveiled this year are still vehicles for boosting GDP, and generating revenue for local governments. These projects would result in the local economic structure getting even worse. While these investment projects, financed by monetary easing, are instant relief for local governments, they are poison for the long term development of China's economy.
Where do the real threats to China's financial security come from?
Xi Jinping stressed recently about the 11 aspects of national security, including economic security and financial security. Yet in fact, the threats to China's economic and financial security are none other than the stimulus policies of the Chinese government itself.
The impressive growth in China's economy in the past three decades relied basically on government-led investment and stimuli. And the government investment was in essence a means to create the so-called economic boom by pumping in more money.
In the last decade for example, China's economy was driven by an ongoing expansionary monetary policy, issuance of bonds, and the ever increasing government investment. The world has seen the result of these practices: China became the world's largest money printer, with huge bubbles formed in the Chinese economy, and local governments found themselves deeply trapped in the quagmire of debts.
In the face of an impending crisis, the central government said during the Central Economic Work Conference in last December and again in the Government Work Report published in March this year that it would implement “a prudent monetary policy”, which meant increase in the supply of money and issuance of local bonds would be stopped.
Now, a month later, the “micro-stimulus” scheme was unveiled. This indicates the central government has run out of options to spur economic development. In the last ten years or so, there were a successive launches of government stimulus—from the construction of high-speed rails, college towns, to real property development—all unable to spur [sustainable] economic growth and left behind massive amount of debts and an economic structure that became terminally ill. Now that the government went back to the old path of driving economic development with government investment, one could tell that the hope for a readjustment in the economic structure has completely lost.
There is a price to pay to readjust the structure of an economy. For an economy as gigantic as China, that price would be huge. The year 2008 was when foreign investment began to withdraw from China, and property prices at that time were not unreasonably high. That was perhaps the last window for China to readjust its economic structure. However, that was also the time when a power transition was about to take place, the government did not want to bear the political risks and they chose the short-sighted option of government investment.
Although their decision proved the “superiority” of “the Chinese model” for the following two years while the world economy encountered difficulties, they missed the last chance to readjust the structure of the Chinese economy.
The truck of the astronomical amount of investment committed after 2009 went into the real property market and the stock market, the only type of companies that managed to reap huge profits were state-owned central enterprises which main business were real property.
Between 2009 and 2013, these type of central enterprises pocketed over 200 billion yuan of profits, whereas immense overcapacity was resulted in other industries that received government investment.
China's investment environment today does not differ significantly from that in 2009, there is still insufficient new realms for investment, the monetary supply increased by the “micro-stimulus” scheme would still go to the real property (new urbanization project) and stock market.
In early April, the relevant departments announced the “through train' direct share-trading between Shanghai and Hong Kong, enabling investors in mainland China and Hong Kong to buy stocks listed in the Hong Kong Stock Exchange or the Shanghai Stock Exchange without having to set up a local account beforehand. Judging from this, it seems the authorities understand very well that the next economic hotspot is “speculation”.
At the moment, China's economic policies are undergoing constant changes and they could differ between one month and the next. As I mentioned above, the central government said in its Government Work Report in March that it would pursue “a prudent monetary policy” (a directive) and then it unveiled in April the “micro-stimulus” scheme (essentially a monetary easing policy). With its economic directive and policies going opposite directions, the fact that China's economy is dependent on government investment in much the same way as an addict who would not be able to get by without using drug should be very clear now.