Changing China

China’s pursuit of stability risks greater stress

By Ethan Devine The author is a guest Breaking Views columnist; the opinions expressed are his own.

While Western economies wither, China is in an entirely different predicament. Beset by high inflation and a frothy real estate market, Chinese policymakers have been trying to cool their economy for going on two years. The central bank, the People’s Bank of China, has led the charge, restricting loans to real estate and hiking the required reserve ratio 12 times in 21 months.

Thanks to this, along with slower growth in the United States and Europe, Chinese inflation is now waning. Add an incipient export slowdown, and China may soon be able to loosen credit to everything but real estate. Neither too hot nor too cold, this Goldilocks economy superficially looks just right for China.

Unfortunately, the reality is that China’s economy more closely resembles a boiling bowl of porridge with a clump of ice in the middle. Poorer provinces are on a debt-fueled construction binge in open defiance of Beijing, so policymakers have to over-tighten where they do have control.

Private real estate developers are unsurprisingly feeling the squeeze, some borrowing at interest rates of more than 30 percent in the black market. Meanwhile, the rest of the private sector is suffering collateral damage. Credit has always been scarce for private companies in China, but now it is practically non-existent. Among the consequences, factory machinery orders are evaporating, and accounts receivable are ballooning as customers take longer to pay their bills.

Since stability remains China’s primary policy objective, some expect policy to ease, particularly with exports poised to slow. Recent riots in Guangdong, the heart of China’s manufacturing industry, are a reminder that a sharp economic downturn could be every bit as destabilizing as high inflation. But much of the Chinese economy is running too hot for wholesale easing.

Construction starts, for example, hit a new all-time high in July. This is particularly alarming since property sales are slowing. Credit-fueled construction may partly explain why China’s debt is growing so much faster than GDP. Fitch calculates that China’s total credit to GDP will end 2011 at 185 percent, up from 124 percent at the end of 2007.