Monday, July 30, 2012

Structural Problems Plague Chinese Economy

By Tianlun Jian

China’s current economic situation is similar to that in early 2009, perhaps even worse. The engine that is driving China’s economy is sputtering. Exports and investments, the main driving forces of China’s economic growth, are slowing down. The real estate industry, the locomotive that just recently pulled the economy, is also weakening. All three aspects are fading.

Regarding inflation, compared with the same period last year, the Consumer Price Index has dropped for three consecutive months, and the Industrial Commodity Price Index has dropped for four months in a row, very similar to the situation in 2009.

But in 2009 Beijing injected a huge 4 trillion yuan (US$585 billion) stimulus package into the economy. While this made up for the lack of demand and managed to maintain economic growth, it actually exacerbated the real estate bubble. The regime panicked as public discontent rose. Neither common folks nor high-class intellectuals could afford to buy a home.

Cash Flow Conundrum

Since last year Beijing has been trying to control the real estate market, but to little effect.

Under such poor economic conditions, lowering interest rates and lowering the bank reserved requirement ratio are measures used to increase cash flow in order to stimulate the economy and maintain growth. However, the increased cash flow can push housing prices up even further.

Maintaining economic growth and eliminating the real estate bubble are contradictory to each other, and that’s why Beijing cannot achieve both of these goals at the same time.

The regime has lowered interest rates twice this year, exceeding measures taken in 2009. The benchmark interest rate is 6 percent, a little higher than the 5.31 percent in 2009. But by allowing a 30 percent discount on the lending rate, the regime has in fact dropped the actual lending rate to around 4.2 percent—lower than in 2009. Beijing would not do this unless they think economic growth is a considerable problem.

The regime has undertaken a series of capital injections to drive the economic growth during the past years, in particular during the financial crisis, causing extra capacities in manufacturing, excessive unsold real estate, and overpriced housing. Now the regime has no more room for stimulation through capital injections.
Most importantly, the capital injections have caused the deformation of China’s economic system, which is very hard to correct, and the regime dares not do this again.


Now, Beijing should not only lower the interest rate, but should also significantly reduce the bank reserved requirement ratio (the minimum amount of funds that a bank is legally required to hold). During the past few years, the regime has significantly increased the reserve-deposit ratio, in an effort to reduce the appreciation pressure on the renminbi, promote exports with a low exchange rate, and maintain high economic growth. From 9 percent in January 2007 to 21.5 percent in June 2011, the increase of the reserve-deposit ratio has deformed the already troubled economic structure even worse.

The engine that drives China’s economy lies in private enterprises and small- and medium-sized enterprises (SMEs). Employment in state-owned enterprises and state-owned holding companies account for only about 20 percent of national employment.

To help China’s economy get out of its current difficulties, current lending policies must be changed first so that the financial monopoly of state-owned banks can be broken. Preferential policies for SMEs and the private sector must be created so that the trade monopoly of state-owned enterprises can be broken.

Unless loans are available for SMEs, the macroeconomics stimulus has no effect, as SMEs cannot benefit from the interest rate drop. If SMEs cannot obtain loans, cannot survive, then talk about China’s economic development is nothing but empty words.

Tax breaks can help reduce the burden on businesses and stimulate economic development, but it is not quite feasible in today’s China. In other words, local governments need to make substantial changes, for example: real reform, deep budget cuts, and putting an end to unreasonable expenses, such as the “three public consumptions”—overseas travel, receptions, and cars for officials, and other perks.

Local governments’ revenue has been increasingly dependent upon land transfer fees for the past ten years or more. In many cases, between 30 and 60 percent of their revenue has come from land sales. Given the current real estate downturn, revenue from land sales is greatly reduced, and has affected the fiscal balance in some areas. Some local governments have to rely on loans to maintain their expenditures.

In fact, local government finances have developed major problems, which cannot be resolved by economic means alone. To fundamentally change the economic system may require first changing the way the government functions.

It would take a minimum of two to three years to adjust the entire Chinese economic policy, and even longer to change the economic structures.

* This article was first published on the Epoch Times on July 30, 2012.