Volume 3 Issue 49: Two-Cent Economics

The China Bears’ Feeble Growl

Taking a break from Eurozone posts. Although all eyes are probably more on Eurozone right now, I think there are still those who are keeping half an eye on China right now. China just cut its required reserve ratio last week, indicating a slightly less bullish scenario on the horizon. But is this the beginning of what is so widely touted as a asset bubble burst? Here is Yu Yongding, the current President of the China Society of World Economics:

"In recent months, bearish sentiment about the Chinese economy has surged, owing largely to three conjectures. First, China’s housing market is on the brink of collapse. Second, China’s fiscal position will worsen rapidly because of massive local government debt. And, third, the collapse of underground credit networks in bustling cities such as Wenzhou will lead to a broad financial crisis across the country. 

In fact, despite its problems, China’s economy remains in good condition – at least so far. Indeed, it is not yet near to hitting the rocks."

Why? The surge in house prices in China is not a full-fledged asset bubble. I say this because it is fueled by real demand, which is opposed to speculative demand. At the core, it is a reflection of the increase in the wealth of the Chinese peopled. Here is what Yu has to add:

But the fall in housing prices is unlikely to turn into a rout, because real demand for houses will remain strong after speculative demand is driven from the market. As soon as housing prices fall to an affordable level, buyers will enter the market and set a floor under the decline.

What about the problem with local debt?

A significant proportion of total local-government debt either has no direct relation to local governments, or cannot be guaranteed by them. Therefore, in legal terms, it is not government debt at all. In addition, given that local-government debt comprises 27% of China’s 2010 GDP, while central government debt and policy loans stand at 20% and 6% of GDP, respectively, the total public debt-to-GDP ratio is approximately 53% – lower than Germany’s. So, while China should not be complacent about local-government debt, panic is unwarranted.

...and shadow banking?

But the severity of Wenzhou’s underground credit crisis has been exaggerated. In fact, Wenzhou’s underground credit accounts for less than 20% of total credit in the region, while the region accounts for less than 1% of China’s GDP. The total volume of affected bank credit in the crisis was just above RMB3 billion – roughly 0.5% of bank loans in the Wenzhou region. So, the damage that the breakdown of Wenzhou’s underground credit networks has inflicted on the regional banking system is limited, with scant national impact.

Source: Project Syndicate