China: Doubts cast on the economic potency of credit expansion


    New evidence suggests that the Chinese housing sector has likely entered into an inexorable decline. More ominously, the once seemingly airtight bond between government-led credit expansion and the vibrancy of China’s housing markets and related industries is fraying. For a government that has staked its political legitimacy largely on its ability to maintain stable economic growth and high employment, the corrosion of credit as a tool for economic management is undoubtedly worrisome.

    According to data released Monday Sept. 15 by China’s National Bureau of Statistics, Chinese industrial production grew by only 6.9 percent year-on-year in August, the lowest such rate since May 2009. Likewise, investment declined in August in real estate construction, infrastructure development and manufacturing, relative to historical levels.

    Perhaps most startling, Chinese electricity production—widely seen as a more reliable indicator of real economic activity than the official gross domestic product growth rate —fell 2.2 percent from a year earlier, the first such outright decline since the global financial crisis hit China six years ago. Relatively mild weather this August, compared with a major heat wave last year, may account for some portion of the dip in electricity demand, but likely not all.

    More important is the harsh reality that China’s housing construction sector—the backbone of national economic growth for the past six years—is slowing and taking the country’s economy down with it.

    Examined alone, August’s declines in economic activity do not portend a major problem. After all, dramatic month-on-month swings in industrial production, investment and housing construction levels have become routine in recent years. But more significant is the concomitance of this decline with the more than threefold growth in China’s overall credit supply between July and August.

    Following a sharp and unexpected drop in new credit creation in July, Beijing pledged to expand the credit supply in August by between $140 billion and $240 billion, a robust sum in keeping with historical averages. It made good on its promise, allowing for $155 billion in new financing to enter the economy.

    This monthly credit expansion was by no means unprecedented. In the past two years, credit grew by $400 billion or more in three separate months. To some extent, continued slowdowns in multiple segments of the economy in August may stem from July’s unusually weak credit expansion. This implies that August’s declines may begin to reverse in September as the increase in credit, along with manufacturing gains ahead of the winter export season, begin to be felt more widely. Nonetheless, the multisector sluggishness in August is alarming because it indicates that the Chinese government’s favored tool for managing the economy—credit —may no longer be powerful enough to prevent the Chinese economy from self-correcting.

    The challenge to China’s leaders is reflected in the growing share of Chinese economic activity accounted for by gross fixed capital formation, a measure of investment into fixed assets that highlights the central role of housing construction in China’s economy. In 2013, a whopping 47 percent of the country’s GDP stemmed from investments in housing construction and ancillary sectors including transport, port and power infrastructure, up from 39 percent in 2007. By comparison, exports accounted for 26 percent of GDP in 2013, down from 38 percent in 2007. Household consumption this year accounted for a mere 34 percent.

    China’s low-cost export sector is a shadow of its former self, certainly not strong enough to compensate for the loss in growth and employment that a sustained housing sector downturn will bring. Likewise, it will be many years before higher value-added manufacturing and domestic consumption—the pillars of Beijing’s broader economic reform and rebalancing efforts—are robust enough to serve as real drivers of the economy. Thus, for the next several years, Beijing will likely continue to rely on state-led investment into infrastructure development to maintain stable growth, much as it has these past six years. That is a tough sell in the face of the seemingly unremitting housing market downturn.

    Stratfor has long noted that the latter half of this decade would see unprecedented challenges to China’s economy, and thus Chinese social and political stability as well. The underlying question has always been whether the Chinese economy can transform from growth fueled primarily by ever-rising factory inputs to stability grounded in profitable, high value-added industries and robust domestic consumption—without first passing through socially and politically untenable bouts of crisis and correction. As August’s data suggests, the answer to this question is coming, and perhaps faster than China’s leaders had hoped.


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