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Is China Running Into Economic Hardships ?

What's happening folks ?

The PBoC (People Bank of China - China's central bank) have recently cut interest rates for the second time in 3 months. It has hardly been the only country to do so lately though (Denmark and Sweden have cut rates in early February). Besides, Europe is getting ready for the first round of its Quantitative Easing (QE) while Japan is still pumping billions into its financial markets. All of this inevitably had an impact on the value of the Euro and the Yen.

Many commentators have discussed these issues and concluded that countries were definitely involved in currency depreciation. The latest of them, Bill Gross, legendary founder of PIMCO, even warned that this undeclared war could result in slower global economic growth, not higher as expected by countries' officials. But we are only interested in one country today and this is China. As the world's second-largest economy, it is one of the main driver behind global growth. Any signs of a slowing down is bad news for everybody. So, we should be all asking ourselves only one question now : Is China running into economic hardships?

Debt levels stand at astonishing levels

Despite having enjoyed double-digit growth rates until the late 2000s, China's debt is one reason to question the viability of the country's economy in the long-term. The total debt of the country (which includes municipalities' and companies') is at an impressive 240% nowadays, which means China is spending a lot of its growth on paying back what is owed to bond holders. China's economic model is known to rely heavily on infrastructure investment and real estate. However, in order to keep up with growth targets designed by Chinese officials, they encouraged investors and companies to go on a credit binge. Inevitably, a bubble formed and when it will likely pop is unknown. But it definitely represents a threat to an awful lot of companies and cities in China, the bankruptcy of which could jeopardize the country's economy. As the country missed its 2014 target (7.4% annually instead of 7.5%), one can wonder whether it is still safe to rely on the country to drive global growth.

Furthermore, these targets, a necessary component of the communist party policy over the past decades, are being ditched by cities such as Shanghai which prefer to aim at "ensuring stable economic growth". Cutting rates was thus the obvious reaction by the PBoC one may say since it will spur spending and revive long-term investments. Nevertheless, as the Economist pointed it out ( www.economist.com/blogs/freeexchange/201... ), what drives credit growth is the ability of the banks to lend (there's a cap on the amount of loans Chinese banks can offer). Though the cap has been raised over the past months, off-balance-sheet lending, i.e investments bank do realize through unregistered vehicles which aren't regulated by the PBOC has been tightened. As a result, there is not enough money flowing into the country. And pumping more money into the system (currently) seems out of the question.

Consumer-based growth should gradually become the norm

It is also worth noting that top-ranking officials in Beijing are starting to advocate for a better-quality growth since building bridges that no one uses or entire cities where no one lives is not what one could deem as well-advised. Speaking of better-quality growth, China has to deal with its lasting problem of pollution. Countless reports of environment damage have been published but action still remains to be seen.

Regardless of the apparent unwillingness of the Chinese Communist Party to go eco-friendly so far, a recent documentary about the worrying levels of pollution and its hazardous effects on health sparked discussions on social networks. It made such headlines that the country had to ban it. We can regret that officials did not seize the occasion to launch a national initiative to reduce the country's carbon footprint, or at least hint at possible future steps towards curbing pollution levels, not least in major cities. Rich Chinese and the increasingly bigger middle-class will be likely to leave the country if they can find better abroad - clean air, top-notch health system and education for their children. It is not in China's interest to suffer a skilled labor shortage.

Deflation risk is looming

Another sign of concern is the risk of deflation the country could be facing in the upcoming months. As yet, industrial output is still growing with the HSBC/Market PMI index standing at a 7-month high. It is not enough though it seems to prevent prices from decreasing as input and output prices have decreased for a consecutive seventh month. As a result, industrial profits slumped. As to consumer inflation, it fell to its lowest level in 5 years in January. Add to this that companies are increasingly unable to service their debt thus leading to an increase in non-performing loans. Banks could then be encouraged to tread too cautiously when it comes to lending. Since we have said the situation is already not that good, downward pressure on prices could go further.

Much remains unknown about the ability of the country to withstand any financial shock, be it because of a credit crunch or protracted low levels of inflation. Chinese people like to say that, unlike their western counterparts, they think on a longer framework and prefer not to rush things. Unfortunately, time's running out and relying on old sayings will definitely not be of any help for them.