Xi’s new normal with Chinese characteristics: James Saft

May 13, 2014

May 13 (Reuters) – The world needs to get ready for a new
normal with Chinese characteristics.

Reacting to yet more evidence that China’s growth is
moderating quickly, President Xi Jinping this weekend more or
less told us to get used to it.

“We must boost our confidence, adapt to the new normal
condition based on the characteristics of China’s economic
growth in the current phase and stay cool-minded,” Xi was quoted
as saying by Xinhua news agency.

What that means for China is not just slow growth, but slow
growth complicated by a lot of debt, a hint of deflation,
trouble brewing in the real estate sector and very limited
policy options.

What that means for the rest of the world is less demand for
natural resources and even less reason to be optimistic about
the prospect for more, well, normal labor markets and inflation.

The idea of the ‘new normal’, popularized by investment
managers Pimco, was that the after-effects of the
over-leveraging and subsequent financial crisis would be a long
period of sub-par growth with all the ills and complications
that implies.

And while China managed to kind of, sort of dodge that in
the immediate aftermath of the crash, courtesy of a massive
stimulus and the resultant real estate boom, its growth path is
now decidedly on the down slope. Trade is actually down so far
this year, and growth may well come in at 7.3 percent for 2014,
which would be the slowest expansion in nearly a quarter of a
century.

What is particularly interesting about all of this is, as
ever, the way in which the huge role and power of the state in
China both simplifies and complicates matters. Xi’s ability to
‘do’ things quickly and decisively far exceeds that of his peers
in the west, but he also may prove hamstrung by the fact that so
much of what he might do involves state-controlled companies and
sectors.

Take, for example, the most recent statistics on bank
lending, which, while below expectations, still showed yuan loan
growth of 13.7 percent. That would seem to be consistent with a
strongly growing economy with ample, if decreasing, credit, but
the reality is a bit more complicated.

For one thing, much of that credit is perforce funneled to
state-owned enterprises. Households and private enterprises only
account for about a third of China’s overall debts, equal to 230
percent of GDP, with state companies and off-balance-sheet
borrowing for infrastructure by local governments accounting for
about half.

STARVE THE PRODUCTIVE?

Leverage in this quasi-state sector has actually increased
in recent years, while households and private businesses have
paid down debts. Therefore the famously underproductive parts of
the economy have been soaking up a disproportionate part of the
available capital, in part because losses make this necessary.

In many ways it is a fun-house mirror version of the
somewhat unproductive and unsuccessful attempts in the U.S. to
goose growth, except rather than choking banks with unwanted
liquidity China feeds state-sector enterprise with credit.

“Granting credit to profitless corporates is not too much
different from having quantitative-easing liquidity trapped in
the commercial banks’ vault,” Societe Generale economist Wei Yao
wrote in a note to clients.

That perhaps explains why it’s possible for China to have
both quite low inflation, outside of food, alongside still
rapidly expanding money and credit supply. The country has a
massive over-supply of productive capacity, much of it in the
hands of entities which simply don’t make much of an attempt to
maximize profits.

Low inflation, falling growth and large debts would normally
call for easing by monetary authorities, but this is far from a
sure thing. China wants to liberalize market interest rates, but
that is a process which elsewhere in the world has often come
along with credit bubbles. If market liberalization is still a
medium-term goal, the scope for easy interest rates is limited.

At the same time, China, like the U.S. last decade, is
facing declining credit availability combined with huge
over-supply of real estate. While many view China’s property
sector as too big to fail, and liable to be rescued by official
intervention, the risk of an uncontrolled re-set of prices,
while small, is real.

As in the U.S., many households are sitting on multiple
properties and a sharp decline in prices could be
self-fulfilling, with developers and individuals both trying to
liquidate holdings at the same time.

That isn’t the central scenario. More likely is the new
normal as promised by Xi: low growth and hard choices about
reform.

The rest of the world may need to get used to living with
far more limited Chinese demand.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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