Building Boom in China Blocks Market Reforms
To look around Shanghai, you wouldn’t think that China is struggling to stave off an economic crisis. Cranes hover over sites for new skyscrapers and apartment blocks, though hundreds recently built are half-empty. Bulldozers sweep away old houses and even new buildings to make way for elevated highways. Steamrollers will soon press runways for the city’s second international airport. The city is building with a fervor that implies boundless wealth.
Thanks to a $1.2-trillion stimulus program that owes as much to China’s traditional command economy as it does to John Maynard Keynes, this nation is gearing up for a binge of infrastructure construction to keep its economy humming while the rest of Asia stalls.
The building boom--financed by bonds, allocated funds and deficit spending--is designed to guarantee China the 8% economic growth rate deemed necessary to absorb millions of laid-off workers this year.
However, it is becoming clear that such growth will come, at least for now, at the expense of market reforms. To ward off economic and social crises, Beijing is reverting to old habits of the command economy: government-mandated loans to state-owned enterprises, price controls on staple goods and tighter rules on foreign exchange and investment.
“This is a sign of desperation,” says Chi Lo, Hongkong & Shanghai Bank’s director of research on China.
The retreat to government-mandated lending may make reforms even harder down the road, he says. “But there is a gamble that if they stimulate the economy now, they can grow out of the problems.”
So far, the strategy seems to be working. In spite of devastation wrought by this summer’s floods and of slowdowns in exports and foreign investment, which were expected to steal a few percentage points from growth this year, the government announced last month that the country was nearly on track with a growth rate of 7.2%.
The stimulus program aims to make up with home-grown demand for the exports and investment lost to the Asian economic crisis. Many of the projects are targeted to create jobs and put money in the pockets of rural consumers in order to develop new markets.
“China has made very ambitious plans during a tough time in the regional economy,” says Li Guobin, a senior economist at the State Information Center, a think tank attached to China’s State Planning Commission.
“Without stimulating domestic demand, the GDP growth rate would not be 8%,” Li says. “It would be just 4% or 5%.”
That would still be the highest rate in Asia, and perhaps in the world. Yet, for China, it is not high enough to spin a social safety net as the command economy lurches closer to a market model. Since last year, the official unemployment rate has more than doubled, to 8%; the number of worker protests has risen along with the layoffs.
Haste of Measures Worries Economists
While the infrastructure spending is expected to add 1 or 2 percentage points to the country’s GDP this year and next, economists worry that China’s haste to kick-start the economy may mean spending now and paying a higher price later.
Some of the projects, such as highways and water treatment plants, are a boon to the underdeveloped countryside. Others add to saturated sectors of the economy, such as power and manufacturing in urban areas.
However, some of the growth is as empty as the new office towers in Shanghai. In this port city of 13 million, office space has risen nearly tenfold in the last four years and is still growing, according to research by the Shanghai office of First Pacific Davies, a Hong Kong-based property firm. In the next two years, more than 10 million square feet of new commercial space will hit the market.
Even though the vacancy rate here is nearly 50% and prices have been halved, cranes that had been idle for the last 18 months as infrastructure lending dried up have started moving now that credit has returned.
Utter Return to Central Control Not Likely
Most analysts inside and outside China agree that the country is not making a full U-turn back to a command economy. But pushing ahead with real market reforms--especially those that would exacerbate unemployment and unrest--may be too painful and precarious during the current economic downturn.
Two of Premier Zhu Rongji’s bold initiatives meant to be carried out this year have been put on the back burner: A plan to privatize urban housing slid past its July 1 deadline, to be resumed sometime next year, and a program to slash the country’s bureaucracy in half was put on hold before it reached the provincial level.
“The social and political ice on which they’re skating has some very thin patches,” says Richard Margolis, managing director of Merrill Lynch in Hong Kong. “The government is pausing to see how much pain can be absorbed.”
Most important, this was supposed to be the year to restructure China’s inefficient state-owned enterprises--the key to the rest of the economic reforms. But despite a directive to cut off loans to failing companies this year and let them die, the central bank on June 25 directed banks to continue lending to struggling state-owned firms. By the end of August, loans outstanding were up 16.4% from a year earlier.
As a result, some factories are rehiring laid-off workers and continuing to produce goods nobody wants. Inventories of unsold merchandise--from color televisions to internal combustion engines--have tripled in the past nine months and now make up 17% of China’s GDP, Chi Lo of Hongkong & Shanghai Bank calculates.
“The government’s reflationary measures have focused on production while disregarding demand,” he says.
That perpetuates a dangerous cycle, Brookings Institution economist Nicholas Lardy says: The factories unable to sell their goods will be unable to pay back their loans, pushing the level of banks’ bad debt even higher. Conservative official estimates say that a quarter of the country’s bank loans are bad--a rate higher than the bad debt levels in Thailand, Indonesia or South Korea before the Asian crisis broke last year.
Analysts say the actual rate may be closer to 40% or 50%.
Currency Policy Averts Speculation
With problems like this, if China’s economy were open, speculators would be rushing in to bet against the yuan, the nation’s currency. However, China has been insulated thus far from much of Southeast Asia’s financial problems because its currency is convertible only for trade.
As fears of depreciation rise, however, investors are finding ways, legal and illegal, to convert their yuan into dollars and move them out of the country, or refusing to bring dollars earned overseas back home. An estimated $20 billion in foreign exchange has disappeared this year alone.
On Oct. 1, the government tightened controls on foreign exchange even further to stem the tide.
“China’s insulation is eroding,” Lardy says. “They are just trying to plug the holes.”
Stricter regulations make business a bit more difficult for multinational companies. The new currency controls mean that companies cannot borrow yuan to prepay dollar-denominated debt and hedge against devaluation of the Chinese currency. Getting approval to pay for foreign parts in hard currency now takes longer, and repatriating profits is harder.
While China still wants investment from overseas, circling its wagons means crowding out foreign investors in some areas.
Only state-owned companies will be allowed to participate in infrastructure projects financed by a recently allocated $24 billion in bonds and loans, an official at the Bank of China told The Times.
China State Power Corp. just announced that it will stop importing power-generation equipment for factories that use less than 600 megawatts--a setback for General Electric and Siemens, which were targeting that niche.
And also on Oct. 1, the government reinforced rules banning foreign involvement in some telecommunications services.
Sprint, Siemens and Deutsche Telekom had been allowed to get around the rules barring foreign direct participation by acting as “consultants” to Chinese counterparts. That door has been closed, shutting out Sprint and Deutsche Telekom and jeopardizing millions of dollars invested in a fixed-line network in the city of Tianjin.
The moves are typical of China’s stutter-step approach to reform, says Bob Broadfoot, managing director of the Political and Economic Risk Consultancy in Hong Kong.
“The government wants foreign participation in key industries. It wants to reform state-owned enterprises,” he says. “But the government never gave up the desire to stay in control.”