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China: sugar rush may be ending

There are signs that China’s stupendous debt-fueled boom is cooling, posing new risks for global growth and markets.

The People’s Bank of China on Thursday raised the bank reserve requirement ratio to a record 21 percent, a rise of a half a percentage point and the fifth so far this year. The move, effectively a tightening of monetary policy, comes as inflation at 5.3 percent remains high and industrial output slides, albeit to a still high 13.4 percent in the year to April.

China is an economy addicted to investment, a sort of fun house mirror of the U.S.’s addiction to consumption, with an astounding 93 percent of GDP growth in 2009 attributable to investment.

That’s a strategy that worked well for years, but China’s response to the global financial crisis, a sort of all-in push for lending and investment, has led to over-heating, uneconomic projects and possibly now a disruptive slowing of growth.

An estimate by Lombard Street Research of broad money growth, including various banking shenanigans, showed growth equal to 40 percent of GDP in 2010, but falling quickly to 23 percent of GDP in the first quarter. Those figures reflect the tremendous growth of money being pushed through the banking system and through a shadow banking system that grew rapidly last year as banks tried to evade government control. The slowdown is almost as striking as the still heady heights of the growth.

That money powered investment across China into infrastructure, industrial production and real estate, sucking as it did tremendous amounts of raw materials and industrial goods from elsewhere in the world.

If Chinese appetite cools, the effects elsewhere will be large, both in countries like Germany which supply goods and places like Australia which supply materials.

There are complex opposing forces in China, with the central bank applying the brakes but other government authorities deeply ambivalent about the implications of a slowdown in investment.

“Historically one of the key indicators that the high-growth investment-driven model has reached its limits as a wealth creator (i.e. is no longer allocating capital efficiently) is when we see an unsustainable increase in debt,” according to Michael Pettis, a professor of finance at Peking University.

“Of course whether or not we have reached this point is still much debated, but I would argue that we started to see this at least five years ago. The surge in banking assets doesn’t give much comfort.”

James Saft is a Reuters columnist. The opinions expressed are his own.

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