Almost daily now, I come across interesting articles on the Chinese economy. Rather than share each article individually, I will from now on provide a weekly round-up of articles from around the web.
If readers have come across any noteworthy articles that I have missed, feel free to add these to the comments section below. Alternatively, if you find any articles of interest that you wish to be included in the weekly summary, feel free to email these to me at [email protected].
On to this week’s round-up, which is centred around the massive malinvestment that appears to be taking place within the Chinese economy.
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Much of this alleged malinvestment is being caused by two main factors: (1) the Chinese Government’s stimulatory policies undertaken in the wake of the global recession, whereby the Government ordered the building of huge amounts of fixed asset investment (namely buildings, infrastructure and factories) and directed banks to increase lending in order to stimulate growth and maintain high levels of employment; and (2) maintenance of artificially low interest rates at China’s Government-owned banks, which punishes the country’s savers (households), thereby encouraging over-investment (speculation) in housing, as well as encourages over-investment by state-owned enterprises that are able to borrow at subsidised rates from China’s banks.
Several articles over the past week have shone a light on the extent of China’s malinvestment.
First, a brilliant (but long) article published in the New York Times, China’s cities digging-up a mountain of debt, provides a fascinating window into the excessive spending by China’s local governments on giant infrastructure projects. Below are some key extracts:
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In the seven years it will take New York City to build a two-mile leg of its long-awaited Second Avenue subway line, this city of 9 million people in central China plans to complete an entirely new subway system, with nearly 140 miles of track.
And the Wuhan Metro is only one piece of a $120 billion municipal master plan that includes two new airport terminals, a new financial district, a cultural district and a riverfront promenade with an office tower half again as high as the Empire State Building.
The construction frenzy cloaks Wuhan, China’s ninth-largest city, in a continual dust cloud, despite fleets of water trucks constantly spraying the streets. No wonder the local Communist party secretary, recently promoted from mayor, is known as “Mr. Digging Around the City.”
The plans for Wuhan, a provincial capital about 425 miles west of Shanghai, might seem extravagant. But they are not unusual. Dozens of other Chinese cities are racing to complete infrastructure projects just as expensive and ambitious, or more so, as they play their roles in this nation’s celebrated economic miracle.
In the last few years the cities’ efforts have helped government infrastructure and real estate spending surpass foreign trade as the biggest contributor to China’s economic growth. Subways and skyscrapers, in other words, are replacing exports of furniture and iPhones as the symbols of this nation’s industrial prowess.
But there are growing signs that China’s long-running economic boom could be undermined by these building binges, which are financed through heavy borrowing by local governments and clever accounting that masks the true size of the debt.
The danger, experts say, is that China’s municipal governments could already be sitting on huge mountains of hidden debt — a lurking liability that threatens to stunt the nation’s economic growth for years or even decades to come…
As municipal projects play out across China, the nation’s spending on so-called fixed-asset investment — a crucial measure of building that is heavily weighted toward government and real estate projects — is now equal to nearly 70 percent of the nation’s gross domestic product. It is a ratio that no other large nation has approached in modern times.
Even Japan, at the peak of its building boom in the 1980s, reached only about 35 percent, and the figure has hovered around 20 percent for decades in the U.S…
China’s state capitalism is much messier, and the economy more vulnerable, than it might look to the outside world.
In the case of Wuhan, a close look at its finances reveals that the city has borrowed tens of billions of dollars from state-run banks. But the loans seldom go directly to the local government. Instead, the borrowing is done by special investment corporations set up by the city — business entities whose debt shows up nowhere on Wuhan’s official financial balance sheet.
Adding to the risk, the collateral for many of those loans is local land valued at lofty prices that could collapse if China’s real estate bubble burst. Wuhan’s land prices have tripled in the last decade…
Dozens of other cities are following a similarly risky script: creating off balance-sheet corporations that are going deeply into debt for showpiece projects, new subway systems, high-speed rail lines and extravagant government office complexes…
This system is not a secret from Beijing, which now says there are more than 10,000 of these local government financing entities in China. In fact, because Beijing now takes a large share of government tax revenue, local governments have had to find their own way to grow, and land development is primarily how they have done it…
The real problem, analysts say, is that municipal government debt in China has begun casting a large shadow over the nation’s growth picture. If instead of investing in growth, China had to start spending money to gird the banks against municipal defaults, some experts see a possibility of China eventually lapsing into a long period of Japan-like stagnation…
Kenneth S. Rogoff, a Harvard economics professor and co-author of “This Time Is Different: Eight Centuries of Financial Folly,” has studied China’s boom. He predicts that within a decade China’s lofty property bubble and its mounting debts could cause a regional recession in Asia and stifle growth in the rest of the world.
“With China, you have the ultimate ‘this time is different’ syndrome,” Rogoff said. “Economists say they have huge reserves, they have savings, they’re hard-working people. It’s naive. You can’t beat the odds forever”…
Wuhan is starting to show symptoms of financial stress.
Despite selling about $25 billion worth of land over the last five years, according to Real Capital Analytics, a research firm based in New York, Wuhan is struggling to pay for its projects. City officials have announced a big increase in bridge tolls. And under pressure from Beijing to reduce Wuhan’s debt, they have promised to pay back $2.3 billion to state-backed creditors this year.
Whether the city would do this by borrowing more money or selling land or assets is unclear. But rolling over old debts with new borrowing is not uncommon among Chinese cities. In 2009, for instance, Wuhan’s big investment company, Wuhan UCID, borrowed $230 million from investors and then used nearly a third of the money to repay some of its bank loans.
Mainly, Wuhan’s leaders are counting on property prices to continue defying gravity, even if some analysts predict a coming crash.
In a report this year, the investment bank Credit Suisse identified Wuhan as one of China’s “top 10 cities to avoid,” saying its housing stock was so huge that it would take eight years to sell the residences already completed — never mind the hundreds of thousands now under construction.
But criticism has not deterred Ruan, the local party secretary, who has vowed to keep his foot on the shovel. “If we don’t speed up construction,” he said in the speech in February, “many of Wuhan’s problems won’t be solved.”
In a similar vein, an article published last week in Zero Hedge provided a fascinating insight into China’s malinvestment via Guangzhou South Station – a giant railway station built in the middle of nowhere that is now almost completely vacant:
When I left my hotel bound for the new Guangzhou South Station the other day , I didn’t know much about the station– where it was, how far from the hotel, etc. After about 25 or 30 minutes in the cab, I still hadn’t seen any signs for the station and grew concerned that the cabbie was just taking me for a ride.
As we eventually approached the station, I began to understand why it was so far out of town. Clearly, the only way they could find enough contiguous land to build this monstrosity was to go WAY into to the outskirts of the city.
In the end, it was a 27.82 kilometer (17.39 miles) cab ride from my downtown hotel, and took 49 minutes to get there. I know this because Chinese taxis are very efficient and give you a highly detailed receipt.
Guangzhou South Station is absolutely COLOSSAL. By comparison, it is much bigger than any of the 3 international airport terminals in Manila where I live… and I’d say it’s over 8 times larger than the Central Airport Express Station in Hong Kong.
For a start, the Guangzhou South Station is built on THREE levels. I was dropped off at level 2. When I entered there was an “Information” booth straight ahead. It was unstaffed. In fact, the entire second level was completely deserted. Very spooky. It was something out of a low-budget zombie movie.
I went downstairs to the ticketing area where there were a few signs of life. Of the forty or so ticket windows, well over half were closed, and there were only a few dozen people mulling about. To give you an idea of density, imagine the largest football stadium you can think of with only a few hundred people inside. Ghost town…
Now, you’d think that if they spent so much money building a station this large, they would be expecting hundreds of trains steaming in and out at all hours of the day. Not by long shot. There was only one train at the platforms. Mine…
When I arrived to Wuhan about 4-hours later (going 300 km per hour on the high speed bullet train), it was the same theme: acres of empty space, hardly a soul in sight, yet all very modern and marbled with dozens of elevators and abandoned information booths. When my train pulled in, it was the only one at the platforms.
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Next, an article published on the China Urban Development blog discusses the opening of the world’s longest sea bridge and an underground tunnel in Quingdao (pictured below).
The bridge stretches 42.4 kilometres and links historic Qingdao with the city’s industrial zone Huangdao. The 9.47 kilometre tunnel also links these two cities, but at a different location (see below map).
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The China Development Blog article raises some major concerns about the efficacy of the project, drawing upon discussion from elsewhere:
As Steve Dickinson of the China Law Blog points out: “The completion of the bridge and tunnel fulfills the long term dream of the Qingdao government to fully integrate the two shores of the Jiaozhou Bay.“
Dickinson goes onto wonder about the possible redundancy of not one but two links across the bay given the high public expenditures of both these projects. At the end of his post, which is titled ‘Qingdao’s New Bridge As Symbol of China Infrastructure‘, he says:
“Nobody is even sure why either the bridge and the tunnel were built, much less the two of them. The bridge seems to be mostly aimed at connection by highway for goods from the ports and airport and tradezones. The tunnel does not provide access to any of this. The high toll for the tunnel means that it will not be used for normal surface transport (private cars and taxis). So why was it built? No one has ever been able to provide me with an explanation. Why was the bridge built at the WIDEST part of the bay? Why was it built when it only provides a 10 minute improvement in travel time? Why was it built with no attention to access and exit? Why were the connecting highways not improved? Who knows.”
Dickinson touches upon what is potentially the most contentious issue about China’s infrastructure: the seldom examined cost/benefit analysis of these new projects. At this point the world knows that China can ‘get it done’ when it comes to building large-scale infrastructure projects. There is no lack of political will or labor to undertake such ambitious plans. Yet lost in the speed of getting these new projects built is a rigorous analysis of the ultimate benefits for what could turn out to be a series of boondoggles.
That is not to suggest that this is not to be expected, especially given that China is a still a developing country. Surely, many of the infrastructure projects will have tremendous benefit now and in the future. I also posit that to some extent China’s leaders are aware of potential labor shortages in the future. As China’s aspiring middle-class urban dwellers move up the value chain, and as the one-child policy begins to take a toll on the country’s youthful demographics, cheap labor will become more scarce.
Given this reality, China appears to be taking an approach that puts speed and ambition above all other considerations, waiting to deal with the details later on. In a sense, this is a cultural phenomenon: creating an environment of rapid growth to ensure social stability and avoid the internal chaos that is still all too near in memory.
For a while now, analysts have been arguing there is a bubble in China’s property market. Using records from 35 major cities this column finds evidence of a housing bubble. It compares house prices to cointegrated fundamentals and finds that property in China is in general overvalued by around 20% – and even more so in the boom towns…
Our results indicate the presence of a house-price bubble. In Figure 1it can be seen that increasing imbalances have emerged over the past two years. For example, real house prices in Shanghai have been 28% above the long run equilibrium in 2008, and 35% in 2009. While the evidence is similar for Beijing, the increase is more spectacular in Shenzhen. Compared to the cointegrating relation, real house prices are overvalued by 66% in 2009, after 23% in 2008. In general, the bubble is more pronounced in the special economic zones and the south-eastern coastal regions. Overall, the size of the bubble is 20% in 2008 and 25% in 2009, regardless of whether GDP or population weights are applied.
That’s all for this week. Once again, feel free to add any links to other relevant China articles in the comments thread. And if you happen to come across any articles worthy of including in next week’s update, feel free to email these to me at the below address.
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness.
Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.
