Vritaanta December 2014

Paathshala
19
have been driven by credit in China
Investments are what have been fuelling the China
story in the past 3 decades. Normally, these investments
rev up the demand for goods, for people, cause
overheat, high wages and high inflation if you are not
too careful.
But that doesn’t seem to have happened in China… so
what’s going on? Well, firstly, once the firms start
spending, they do drive demand for investment
goods. But the cost of labour in most Chinese enterprises
is low. Even with the understanding that it’s
increasing, it’s still much lower than in any other developed
economy and hence an increase in investment
spending does not push household incomes to
the extent you’d expect. Secondly, your average Mr.
and Mrs. Lee, on getting the income, want to save.
Now, that means that the households’ precautionary
behaviour helps to keep the consumer goods inflation
well under control, even with higher incomes getting
built into the system.
But that’s not all. We need to focus on those activities
that are getting funded through these deposits created
by the Chinese households. And, in the past three
years, a major chunk of these savings were given out
by banks to people who wanted to buy – property.
The same property, at higher and higher prices.
Now, this means that it wouldn’t really create a demand
the way that investments in plant and machinery
would. So there has been no major ripple effect on
demand for investment goods and services and hence
obviously, while savings and investments and the
credit binge continued, the GDP would slow down.
Which it did!
Realise again that the GDP would only be “fresh” production
of goods and services and so the same property
being bought over and over again wouldn’t really
contribute to the GDP growth rate. But it would contribute
to something else – a property bubble.
So, you would get a paradoxical kind of a scenario,
with higher property prices, higher savings, higher
investments, higher credit – and lower GDP growth
rates!
These have been the characteristics of the Chinese
economy over the past three years, and the signs of
weaknesses seem to be compounding recently.
There’s also been talk of “malinvestments”; which is
the right type of investments that create multipliers,
but not really required for the economic system. You
build urban areas with no people living in them and
new roads with no one to drive on them. That creates
employment and demand in the interim period, but
end of the day, it’s investment that is not immediately
useable. And at a time when the credit supply is increasingly
directed towards the property bubble, the
opportunity costs of such investments are huge.
There’s more to it – there’s the Chinese version of
Lehmann – fondly known as shadow banking. As the
policy makers tightened the pace of bank lending to
“bubbly” projects such as property, such projects have
increasingly been seeking credit from “shadow” banks
or trusts. These trusts offer a return of more than 10%
to retail investors. Trusts only have to match the frustration
of the lenders with the greed of the borrowers
and you get a first class shadow bank, adding further
fizz to the property boom.
Some industries have grouped together to avail of
funding and in the process, have guaranteed each other’s
loans. To the extent, these loans have been channelised
towards property or steel, both of which seem
to be cooling off significantly, owing to the mere fact
of oversupply. It creates a strain on the capacity to
return the loan, causing stress to the guarantor, the
trust as well as the household, whose money is involved
in this scenario.
All this has prompted regulators to move predictably,
slowing down credit growth through rate hikes, by
taking decisions to close down some steel factories
and by clamping curbs on property deals by households.
This has caused the cost of debt to go up in a
broadbased fashion, thereby lowering the growth prospects;
the property curbs have led to lesser sale of
houses and increased financial vulnerabilities.
This is a genuinely difficult one to handle. Much as no
policy intervention will worsen the problem, so will
any policy intervention!
December 2014