IER Wen Jiabao’s speech to the National People’s Congress has caused a wobble in Chinese equities and reduced the optimism that was building on China. His forecast for 7.5 per cent GDP growth in 2012 is below what some international agencies were expecting. The biggest surprise about Wen’s forecast is that it is also a surprise to the markets. Wen has been managing down expectations about growth for some time, and it is apparent from a range of indicators that the Chinese economy is slowing.
Indebtedness is the key issue for investors, particularly whether slower growth exposes bad loans. Some believe there is a conspiracy of silence over bad debt in China and that unmanageable non-performing loans will crawl from the woodwork in the coming months. This fear does not reflect the reality.
As Greece has discovered, a problem arises when debts cannot be repaid when they fall due or when they are called. Given China’s closed capital account, the banks have a secure deposit base and therefore a stable funding base. They can afford to roll-over debts and wait. The vast majority of loans are domestic, and most are government-linked, meaning they are unlikely to be called. By increasing the banks’ reserve requirement ratio in recent years, the authorities have consciously tried to restrict monetary growth and store up deposits at the central bank. This liquidity is now substantial and helps insulate the banks against an increase in non-performing loans from a currently very low level.
Some issues have been reported in relation to local government financing vehicles, but the government has assessed the actual exposures of these entities to be manageable. Much of this debt is against infrastructure projects, financed over an inappropriately short period, but is likely to be repaid over the project life. Rolling over short-term debt is common practice in China due to the structure and immaturity of fixed income markets. Arguably, the debt write-offs against the Humber Bridge in the UK provide a more egregious example of the failed public finance of infrastructure. But this has not earned the same column inches as Chinese infrastructure financing.
China is well capitalised and liquid. Credit tightening has created problems in certain sectors but China is a long way from crisis. It is moving into a new phase of development, where the quality, not just the quantity, of its economic growth is paramount.
Wen’s speech dealt with more than economic forecasts and highlighted progress in building the Chinese nation, with an awareness of the complex needs and happiness of its people. Growing consumption is part of this awareness, and it featured as the government’s first major task for the coming year. Rebalancing growth means adjusting income distribution. Wage rises have been mandated by the government to improve the spending power of lower income groups.
There is plenty of growth to come. Wen highlighted the redevelopment of the industrial northeast and the potential of the centre and west. China’s growth has slowed, but it is still rapid for its size, and will not provide the catalyst for a bad debt crisis.
James Weir is co-manager of Guinness China and Hong Kong and Asia Focus funds.