By Geoff Dyer
Published: February 21 2010 19:39
Chenggong is a new town near Kunming, one of the main cities in the south-west of China. Construction started in 2003 and the results are now apparent in 13 immaculate local government buildings, each clad in marble tiles. A high school boasts an impressive indoor swimming pool and several of the region’s main universities have built large campuses. Pristine high-rise apartment blocks stand in rows, their new windows glinting in the subtropical sun.
The one drawback: at the moment, Chenggong is almost completely empty. Its wide streets are all but bereft of traffic, a bank branch has no customers and leaves collect in the foyers of the municipal offices.
It is places such as Chenggong that are starting to divide opinion about what is really happening in the Chinese economy. China was the big winner from the global crisis, with its economy expanding by 8.7 per cent last year amid recession elsewhere. But as the country returns from its lunar new year holiday, divisions are emerging over the long-term impact of the stimulus package implemented by Beijing to carry it through the international downturn.
While some regard China as having made forward-looking investments in infrastructure and urban planning that will lay the foundations for a new burst of growth, others fear last year’s recovery is really a mirage based on an investment bubble. It is also a crucial question for the fragile global economy. If China’s rebound were to fizzle, it could easily drag the rest of the world into a double-dip recession.
Within the government, there is sharp debate about the risks from last year’s credit binge, which saw the number of new loans double. Some officials want to keep the investment taps open because they fear the economy is still weak, while others worry about looming threats of inflation and overcapacity.
Among professional investors, views are even more polarised. Anthony Bolton, the prominent British investor, recently announced he was moving to Hong Kong to manage a China fund and purred about “the effectiveness of the centrally run economy”. Yet Jim Chanos, the hedge fund manager best known for seeing the fiction in Enron’s accounts, says the very same centrally planned system has created “an unprecedented bubble” in investment, especially in real estate. Both sides can find ammunition for their arguments in Chenggong.
Three sets of worries are in evidence. The first is that investment is now carrying too big a load in the Chinese economy. According to Yu Yongding, an economist at the Chinese Academy of Social Sciences, investment that was once about 25 per cent of gross domestic product is heading towards 50 per cent. “The rapid increase in the investment rate is creating serious problems. It is already too high and it is still increasing significantly,” he says. “All of this means that in the future, China’s overcapacity problem is likely to become much more serious.”
Historical comparisons suggest there is something unprecedented in China’s investment boom. Even before last year’s surge, the Economist Intelligence Unit notes, China’s investment-to-GDP ratio was the same as Thailand’s on the eve of the 1997-98 Asian financial crisis, or Japan’s at its peak during its high investment phase in the 1960s.
Prof Yu says the system encourages local governments to invest in trophy projects, such as gleaming new towns and administrative centres, because officials sometimes do not care if the project is barely used in five years’ time as they will by then have moved to a different job. “There are big institutional reasons for overcapacity. Local governments have a strong motivation to create this investment,” he says.
The second worry from the stimulus is thus that it creates financial bubbles, especially in real estate (see below). Beyond that, the third fear is that the flood of new lending will end up as bad debts. This is particularly the case for local governments, which have been at the heart of most of the infrastructure spending, usually through thousands of specially created investment vehicles funded by bank loans.
Victor Shih, an academic at Northwestern University of the US, sifted through local government documents and ratings agency filings and calculated that mainland local governments now have debts of Rmb11,400bn ($1,670bn, €1,235bn, £1,085bn), which is more than double the official estimate and is equivalent to one-third of GDP. Banks have agreed to lend a further Rmb12,700bn by 2011 to these local government companies, he says, some of which are bound to struggle to repay the loans.
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“My numbers are a conservative estimate as there are probably a lot more loans out there that we do not know about,” he adds.
Yet even though all these risks are present, some economists believe that the actual threat is being vastly overstated. For them, places such as Chenggong are not waste but a much-needed upgrade for the poorest parts of the country.
Chen Lijun, an economist at the Yunnan Academy of Social Sciences in Kunming, points out that the centre of his city – which lies about 20km from Chenggong – is overcrowded. As a result, he says, it will only take a few years before new projects such as Chenggong are fully occupied. (Some city government departments will move to the new town in the summer.) The Chenggong project is only one part of a makeover of Kunming city and the province of Yunnan, where officials argue they are making up for lost time.
“When China started reforming the economy, the east developed first and then the centre and only after that the west and south,” says Prof Chen. “Kunming missed a chance to develop as quickly as the coastal cities, which left us with a lot of challenges.”
The local government hopes to reduce the city’s intense traffic congestion by building 15 new bridges or flyovers – models and artists’ impressions of which are all on display at a brand new urban planning museum – as well as constructing a 163km-long light rail network, which will soon link Chenggong to the city centre. Meanwhile, a high-speed rail line will connect Kunming to Shanghai, nearly 2,000km away, and help bind this once isolated region more closely into the national economy.
The investment boom is also intended to reorient the region’s economy, which has long focused on China’s richer east coast, towards its south-east Asian neighbours. The construction of a bridge has completed a road linking Kunming to Bangkok, while a bridge on another road joining Yunnan with northern Vietnam is nearly finished. Road and rail links to the border with Burma are also being improved and a Rmb23bn airport is under development, with the aim of making Kunming a hub for tourism in south-east Asia. “If the transport links were better, our trade with south-east Asia would double without any problem,” says Prof Chen.
Peng Wensheng, an economist at Barclays Capital in Hong Kong, says sceptics worrying about excessive investment in infrastructure forget that in development terms China is more like Japan of the 1950s and 1960s, not the bubble-era 1980s. In other words, large parts of the country are still in dire need of infrastructure.
He adds that the government was smart to push through the recent surge in investment because in a few years its greying society might not generate the financial resources to make such bold plans. “Savings will start to drop after 2015 when the working population starts to decline,” he says. “Before that, we have five years to build a modern infrastructure. It is not only a convenient way to deal with the decline in exports last year, it is also a necessity for the country.”
So who is right? The figures are inconclusive but they do suggest China still has some breathing room. If the economy were drowning in overcapacity, there would be a dramatic decline in efficiency and returns on investment, suggesting much slower growth in the future.
Prof Yu says this is already evident in the figures for the incremental capital/output ratio, which measures the efficiency of investment. (A higher number means a country needs to invest more to generate additional output.) In Japan during its investment boom, this figure was about three, and in China from 1991-2003 it was 4.1. Yet as a result of the stimulus it is now above six, he says, which is a large red warning light.
Some economists point out, however, that during the previous decade, when warnings about overcapacity and overinvestment were widespread, corporate profits actually increased, even if specific sectors suffered at times. And academic research has suggested that returns on capital remained stable.
Moreover, high rates of growth can make overcapacity problems disappear quickly. As Mr Peng puts it: “Any investor who based his views on China on the idea of overcapacity would not have made any money over the last 10-15 years.”
The other question is will the financial system become clogged up by bad debts? The figures produced by Mr Shih are giving many economists pause for thought about the potential bill from the stimulus package, especially given how little is known about how the money was really spent. “There is so little transparency, so little visibility – that is what is worrying about the investment boom,” says Bill Adams at the Conference Board in Beijing.
Yet unless the bad debts become an avalanche, China has the ability to absorb a large number of non-performing loans without it undermining the financial system. With $2,400bn in foreign exchange reserves, it can easily recapitalise the banks if they run into problems. Indeed, that is exactly what it did in the early part of the last decade after the main banks became technically insolvent from a previous credit binge.
Arthur Kroeber, editor of the Chinese Economic Quarterly, points out that if reasonable rates of growth are maintained, those bad loans will rapidly decrease as a percentage of GDP over the course of the decade. Previous scares about empty infrastructure, he points out, often evaporated when the projects became fully put to use a few years later.
But even he thinks China cannot keep using its banks for much longer to push through loans for infrastructure projects with questionable finances. Bad debts would otherwise become dangerously large and China needs much more efficient allocation of capital if it is to keep growing.
“We are getting to the end of China’s ability to finance growth in this way,” he says, adding that the central planners in charge “can probably get away with it this time – but if they keep trying to do things this way, they will get into trouble”.
Lavish lending
China’s rebound from the global crisis has been based on a massive stimulus programme. The pure fiscal boost last year was limited, with the government deficit coming in at 2.2 per cent. But new loans more than doubled last year to Rmb9,600bn ($1,405bn, €1,040bn, £910bn) after state-owned banks were ordered to back as many infrastructure projects as they could. If new bank loans above what might be expected in a normal year are included, the fiscal stimulus was as large as 15 per cent of gross domestic product.
Property perils
‘WE NOW HAVE A BUBBLE IN MANY CITIES, PARTICULARLY THE BIG ONES’
Chenggong may still be largely empty but it is already attracting the attention of property speculators.
At one of the town’s many estate agents, a Mr Xin is eyeing up new apartments. Originally from Wenzhou, the east coast city that is synonymous in China with free-wheeling capitalism, he already owns eight flats at a compound called Huilan Yuan, which had in theory been set aside for civil servants moving to the town, but he is interested in more. “I think it is a good idea to invest now before the property prices in Chenggong start to rocket,” says Mr Xin.
If there is one big idea to come out of the financial crisis, it is that monetary authorities should try to anticipate asset price bubbles, especially in property. China is now a test-case for the theory, given strong indications that the property market is getting close to bubble territory.
Hoarding empty flats in the hope of price rises is one indicator, but there are others. According to Standard Chartere
d, the average land price in China increased by 106 per cent last year. That includes an increase of more than 200 per cent in Shanghai, nearly 400 per cent in Guangzhou and 876 per cent in Wenzhou. “We believe we now have a bubble in many cities, particularly the big ones,” says Stephen Green, economist at the UK-based international bank.
Prices of land and property are central to the economy’s prospects. Not only is real estate investment a significant driver of growth in gross domestic product but land sales are a vital source of revenue for local governments and they provide the financial backing for a large part of China’s infrastructure investment. So while the Chinese authorities cannot allow the market to become too frothy, they equally cannot afford a sharp drop in prices, which could also cause a great deal of collateral damage in the economy.
As a result, Beijing is trying gently to slow the market. Tight controls over the financial system give it more levers than are available to regulators in other countries. The authorities now require a 40 per cent downpayment on mortgages for a second home and developers sitting on unused land face tougher penalties. Informally, banks have been urged to scale back lending to some developers.
Some local markets are still buzzing. In the southern China island of Hainan, a property rush in the first few weeks of the year sent prices up 18 per cent and by more than 50 per cent for some buildings. But there are reports that transactions in several of China’s biggest cities slowed last month, which could be the precursor for a more orderly market. Beijing will certainly be hoping so.
Copyright The Financial Times Limited 2010.
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