After a visit by the the International Monetary Fund staff team in China, the “End-of-Mission” statement – published November 7 by the IMF - conveys Article IV preliminary findings
In compliance with the Fund's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country to collect economic and financial information, and to discuss with officials the country's economic developments and policies
Defined by the IMF charter, the visits underscore the potential and the challenges confronting a member country with carefully worded guidelines of economic and financial recommendations
The status and requisites for China are no different
But the IMF's thoughtful wording calls for careful interpretation because "all things China" - especially regarding economic growth and trade - carry global implications
Comments on challenges and recommendations have significant because of China’s weight in global trade – to say nothing of the political commitment of China’s ruling party, the CCP (Chinese Communist Party), to the country’s economic success
This is how the IMF’s note manages simultaneously to point all the critical issues and imbalances putting China’s growth at risk while voicing confidence in the country’s leadership to address these issues successfully
China – a broken growth model – showed how the imbalances stress the country’s decades-old expansion
Restated by the IMF's First Deputy Managing Director, Ms. Gita Gopinath, in no uncertain terms,
“Over the last few decades, China has outpaced other nations at similar levels of development, growing at over 8 percent annually since 2000, significantly improving living standards, and eliminating extreme poverty. However, China’s credit-fueled growth in recent years was accompanied by widening imbalances and rising vulnerabilities. Excessively high household savings were used to finance infrastructure and residential investment with diminishing returns, resulting in elevated debt levels.”
Erring on the side of caution, Ms Gopinath did not put her stark analysis in context
- It is proper to highlight China’s growth since the country’s accession to the World Trade Organization (WTO) in 2001 which boosted its economic prowess immensely, charted in a 2021 UNCTAD comparison between trading partners
- The ‘elevated debt levels’ noted by Ms Gopinah however are, for the better part, the unwanted heritage of a tremendous infrastructure push since the Great Financial Crisis
- In 15 years since 2007, China's already significant total debt-to-GDP has doubled to 280%, according to official data
Those infrastructure investments were financed almost exclusively by China's local governments, as central government's infrastructure commitments have remained below 10% ot total
The conundrum of local governments
Pressed to overachieve national guidelines, local officials have been eager to comply
In a precautionary regulatory twist, local governments were not - in principle - alllowed to borrow
None of which was going to hold back the investment push...
Special entities - the Local Governement Finance Vehicles (LGFV) - circumvented regulatory constraints to secure infrastructure financinge and were implemented on "continental" scale
Local debt exploded
Actual local government debt is huge by any measure at 80 trillion yuan ($11 trillion) - more than 60% of China's annual GDP - of which 54 trillion yuan ($7.5 trillion) are interest-bearing , mostly owed to Chinese bank, according to Reuters
Extending credit under the probable assumption that Central Government would ultimately guarantee local debt repayment, the banking system nevertheless felt entitled to levy interest rates approx. 2% above national key rates...
China's central government has not yet been quite as forthcoming
Another nail in local government coffins
Unquestionably, the financial status of local governements differ by a wide margin - from favored Eastern seaboard regions where budgets will balance out over time to hard-hit governments in impoverished regions, deep in the country
It remains that prolonged weakness of the key resource balancing regional budgets, landsales to property deveopers, will hit every regional government, large and small
As noted by the IMF, "the authorities’ goal to engineer the needed adjustment in the property market is welcome", refering to forceful policies to rein-in debt build-up of key real estate developers
Pacing local governmental debt, real estate debt is awesome, confronting central decision makers with an uncomfortable truth
China’s growth model relied in large part on expansion of the real estate sector, which itself relied on debt
Considering the two largest operators, Country Garden and Evergrande,
- Country Garden recorded more than $180 billion in liabilities as of June 2023 and Evergrande had debts amounting to more than $300 billion - extraordinary numbers which still must be compounded by off-balance sheet debt for unknown amounts....
Deep malaise of the real estate sector hangs over financial health of local governments
Given time, economically affluent regions will have every chance to weather the storm, less favored 'hinterland' regions may not...
Debt, even immense debt build-up as large as China itself, has been key to the country's record growth
And the reverse is also true, record growth supports the payback of debts when they come due
Faltering growth
Growth rates may still be outstanding, just not as outstanding as they used to be ...
And the IMF's report on official projections regarding medium term growth may be the most potent piece of information
" Real GDP is projected to grow by 5.4 percent in 2023 and slow to 4.6 percent in 2024"
"Over the medium term, growth is projected to gradually decline to about 3½ percent by 2028 amid headwinds from weak productivity and population aging"
Projections for 2023 and 2024 may - or may not - reflect economic reality, as discussed in "China - Rearranging the Deck Chairs..."
Medium-term, within 5 years, the fall by 50% of projections to 3.5% (compared to the 8% 20-year trend) upends the Chinese growth mode
And there is good reason to be upfront about the assumption
This is because the third engine of Chinese growth, next to infrastructure and other government spending, and exports, is definitely sputtering
Domestic consumption is an indispensable component of GDP growth everywhere, and consumption is not just going through a weak spell..
Chinese consumption is structurally weak - for a variety of reasons from the one-child policy (1980-2016) to old age insecurity and income inequality
- At 46% of GDP, gross domestic savings (households, corporate and government) in China are more than double the global world average (20%)
- With corporate savings broadly in line with the global average (at approx. 20%), household savings are the drivers of the savings rate differential, at approx. 23-25% of GDP which are more than three times higher than the global average (7-8%)
The IMF may be right to put the Fund's trust in successful reblancing of the Chinese economy and it would not be the first time that China surprises by deft manoeuvrering out of a tight corner
There is little doubt however that China's central government will be called upon - in yet unpredictable fashion - to support not only real estate developers, turning out to be 'too big to fail' but some of the local governments and the State banking system itself...
A tight corner indeed