Cross-posted from Investing in Chinese Stocks.
From Chinese Premier Li Keqiang:
We will not pass “strong stimulus”, “flood irrigation” investment to expand domestic demand. iFeng: 李克强：不会再通过“强刺激”的投资来扩大内需
One of the big themes I covered here in recent years was the leadership transition (lots of links at bottom of that post) and the economic thinking of the new regime, mainly Li. I summed up a lot of this in an article here: China’s New Age Of Reform. From the summary points:
Rhetoric has been followed up with action, with major reforms in the SOE and financial sector underway.
Monetary stimulus is off the table unless the economy slows substantially or the reform camp suffers a political setback.
It turns out reforms are moving much slower than expected, but monetary stimulus continues to be doled out in doses only large enough to prevent a crisis.
The leadership has been saying no stimulus for several years. It is a message I covered repeatedly on this blog because foreign media kept repeating the “China stimulus” theme in past years. Li Keqiang in particular has consistently voiced opposition to such a stimulus and it continues to this day in the midst of a serious slowdown. He is not wrong on the economics. Making the hard choices is what good leaders do. Stimulus and currency devaluation are the policies of weak leaders and almost never resolve the underlying problems. As in 2008. The biggest difference between 2016 and 2008 is amount of debt. What was a big problem has grown into an incomprehensible crisis.
Li may also be right on the politics of deflation. The leadership has been jailing corrupt politicians at a healthy clip and removing their political opposition. There are still many party insiders who oppose the economic reforms because it will take money and economic power away from party officials up and down the line, as well as introduce market forces and foreign influence into the economy. Local governments have refused, at almost every turn, to implement the leadership’s policies on reforming local economies. The best way to push reforms then, may be to break their enemies with deflation.
China is already on the path to reform. The leadership is moving slowly because they don’t want a disorderly transition. They want the growth from new markets to offset the slowdown in old markets, but if there is a crisis of any size, it will accelerate reform, not derail it— assuming the leadership has consolidated power and squelched opposition.
If there’s no credit, then it’s game over for every over indebted local government and state-owned enterprise.
Li has been saying the exact same thing on economic policy going back at least to 2010. Many reforms such as property taxes were part of a push to build a Chinese middle class. The political leadership that designed the 2008 stimulus has seen its power diminished, with the PBoC becoming more powerful than the Ministry of Finance. For those who lean towards the political intrigue, a brutal deflation would wipe out many political enemies because the companies and governments under their control will go bust.
Going back to the economic policy. More than a year ago here: Kuroda Says Dump Yen, Yuan to Fall
China cannot simultaneously cut interest rates and expect the yuan to appreciate because hot money will flow out of the country. Short of igniting an economic boom, a yuan rally isn’t going to happen. Since the leadership does not want an investment led boom, which is the only way the current economy would be able to deploy massive capital inflows/credit growth, the hot money will leave if rates continue to slide. The other option is to let the tight credit conditions deflation do its work. The painless short-term solutions are gone. Long-term, reforms will lift the economic growth rate, but short-term there are no painless or costless options.
The point I’ve been trying to drill home on the blog is that China faces no pain free choices. It cannot control the laws of economics, but it can control where the fallout lands. Yet until recently, the “mainstream” opinion on China was still that their reserves and the ability to do stimulus would allow them to avoid any real pain.
Now the mainstream is finally coming around to the idea that China has to pay the bill for its 2008 stimulus binge.
The Australian: China’s tough reform choices as ‘era of easy growth over’
Some economists don’t rule out an abrupt drop in growth, a hard landing that would see bad debts soar, consumer confidence tank, the Chinese yuan plunge, unemployment spiral and growth crater.
More likely is that Beijing will continue to prop up growth, steering more capital to money-losing companies, unneeded infrastructure and debt servicing, depriving the economy of productive investment and leading to the sort of protracted malaise seen in Japan in recent decades. But China is less prosperous than Japan.
…“They don’t want to take the pain,” said Alicia Garcia Herrero, economist with investment bank Natixis. “But the longer they wait, the more difficult it becomes.”
I suggest that this type of statement should be accompanied by the question, “Who doesn’t want to take the pain?”
This moment was unavoidable. Xi and Li have been on the right path with economic policy and based on the consistent public statements by Li, they haven’t deviated from their agenda. (The stock market bubble is a glaring exception.) That reforms haven’t been implemented and overcapacity is still a major issue could reflect a lack of commitment by the leadership, but I don’t believe this to be the case. In addition to consistent public comments on policy, there are reports of Li’s “table pounding” moments in closed door meetings with local officials in past years. More likely is there is still hefty political opposition. High-ranking officials with personal interest in preserving the status quo to those at the bottom in local government form a powerful bureaucratic opposition. Add in legitimate fear of a major economic crisis among the leadership, plus a belief or desire that reform be achieved with as little pain as possible, and it’s clear why Xi and Li may not have pushed reforms hard enough to overcome opposition. It is a natural tendency to avoid painful decisions, especially when one still hopes there might be a better outcome. Plus, if you act early and trigger a smaller crisis, you are blamed for the crisis, not the avoidance of a depression. Even in a non-democracy like China, the political pressure pushes one to wait until the crisis is full blown. We should know by March, after Spring Festival, if the leadership will finally start managing the crisis rather than reacting to it.
Although devaluation is a bad policy as a solution, I have forecast yuan devaluation for several years not because I viewed it as inevitable based on the growth in debt, the trend in the U.S. dollar and economic history. At some point, the imbalances will end. Liabilities and assets must balance. With potentially trillions of dollars in bad debt, either the debt collapses and asset prices follow, or the currency collapses to “save” the debt and nominal asset prices. If China did implement another 2008-stimulus, it is currency devaluation by another name. In keeping with the reform ideas of Li and the PBoC, it is much preferable to have the international currency market force the yuan lower, then to resort to a stimulus that will end up having the same currency effect, but in the process, set reforms back a decade.
All of the above has analysts suddenly mulling a rerun of 1998 for China. The Economic Observer has two articles looking back to 1998 on economic reform. First is an interview with Zhou Fangsheng.
From 1991 to 1997, Mr. Zhou served as deputy division director and division director in State-owned Assets Administration Bureau, and deputy director in Stated-owned Assets Administration Research Institute. From 1997 to 2001, Mr. Zhou worked as deputy director in difficulty relief working office for state-owned enterprises of State Economic and Trade Commission. EO: 98企改亲历者：供给侧改革如何减少阵痛
He was in charge of SOE reform at that office. He is now retired, but he has been studying the local economies of Northeast China. Quick summary: China has faced overcapacity before and it was met with reform such as 1998 with Zhu Rongji, but in 2008 pain was avoided and the overcapacity problem became much worse. Overcapacity is probably close to 50%.
Economic Observer: You served in 1998, deputy director of the State Economic and Trade Commission office SOEs turnaround from these “real” experience to analyze the supply side of the reform is now the central authorities, and the previous state enterprise reform, the most fundamental change in where?
Zhou: Since late last year, I was doing some research in North Eastern Province, Shenyang, Harbin and other places. Now I’m retired, so to run the business is also convenient than the original, but can see, we learned a lot more genuine contradictions and problems.
Through the investigation I found that the current difficulties in the Northeast state-owned enterprises has been very severe.
The supply side of the reform of the central government, supply and demand are two sides of a problem, according to my understanding, the supply side of the reform is not a fine-tuning, but 180 degrees out of the head, from the demand side to solve the economic problems, the conversion to the From the supply side to solve the economic problems. Economic policy when we lost such a big head? No! 1998 is the direction, but did not like the mention of so clear. My understanding is this.
From the 1980s, national overcapacity has occurred at least 3,4 times, overcapacity each time more serious than the last, especially in 2008 and now this. 1998, Zhu Rongji also start from the supply side reform, such as the textile spindles, but by administrative means pressure capacity measures 2008 overcapacity is taken to stimulate demand, the result of overcapacity problem worse. You think, already overcapacity, and also stimulate the market from the demand side. Originally the market demand is not so big, is to stimulate out by administrative means, gave the market an amplified erroneous supply side signal. Resulting in excess capacity today to be more severe than in 2008, figures in several industries statistics down, overcapacity is probably closer to 50%. I think that this supply-side reform is the right choice, the whole direction, the direction of the original solution to the problem in question.
He goes on:
The Economic Observer: 1998 loss-making state-owned enterprises was 39.7 percent, and now it seems the entire state-owned loss is more serious. Recently we have seen a profile of Shanxi, said Shanxi is the most difficult since the reform and opening period, until November 2015, Shanxi 119 counties (cities, districts) have revenues 87 counties negative growth.
Zhou release: From my research in the Northeast, the Northeast now face a loss of more than 60% state-owned enterprises in fact, the situation may be more severe in Shanxi. Now the country is the number of loss-making state-owned enterprises that do not know, because we have not seen published figures in this regard.
The Economic Observer: Do you think, now what SOE reform is the most critical issue is?
Zhou released: first to admit that the whole state-owned enterprises has been very difficult, partly state-owned heavy losses of reality, if you do not recognize the reality that what is to solve the problem?
If you said the situation is excellent, everyone would think there is no need for the reform. Zhu period in 1998, the first is to recognize the reality, it is difficult to recognize state-owned enterprises, state-owned enterprises to achieve three central determined turnaround. Turning around the premise that the presence of recognition problem. Acknowledged difficulties, you can face it and face reality, you can take action.
Recently the central government reform is mainly supply-side capacity to do a good job, go inventory, deleveraging, lower costs, make short board “five key tasks,” which, at least the first three, all acknowledge the existence of state-owned enterprises reflects the problems. There is an old saying, that acknowledged the problem, the problem is half solved.
Another is to deepen understanding, determined to promote supply-side structural reforms, there is a clear idea, there are clear thinking, as well as specific tasks. “To head-to stay here, to dry firmly, boldly dry, solid ground dry, dry accurately, and never looked back to dry.”
The second article also looks back at 1998 reforms 中国经济 温故1998:
From 1993 he began as the National Bureau of Statistics chief economist, and later went to assistant governor of Anhui Province, sending experience, let him understand the profound to the Chinese economy heavily ill and micro sores.
He found that in a survey of the year, the country has about 96% of industrial consumer goods in oversupply or supply and demand balance; Liucheng enterprise reflect an oversupply of production; processing industry capacity utilization less than 50% of enterprises in the three more than one-half. 380,000 independent accounting industrial enterprises of finished products amount of funds used more than 600 billion, of which non-normal occupancy of nearly 200 billion.
The article also discussed an event that crystallized the reforms, the literal scrapping of a textile factory, following all the way to a furnace at Shanghai Iron & Steel.
Massive NPLs and a banking system bailout marked the end of the 1998 reforms, in the early 2000s. How high will the pain rise?
Guotai Junan’s chief macro economist Ren Zeping says China will enter an L-shaped recession from which it will not emerge for at least three years.
The next three years China’s economy will not recover, I put forward last year, China’s economy over the next three to five years may be an L-shaped, but the L-shaped background that is not calm, because the old model will be ended, the new model will rise.
He raises the issue of NPLs, bringing to mind the recent discussion of 1998 reforms:
However, I would like to say that we do not have too idealistic reform ideas and fantasies. Three years in the throes of reform there can be no dividend, but will have no future without reform. Now that you have talked about the supply side of the reform, we re-normal growth rate shift comes to the supply-side reforms, we recognize that given the means in place to solve, we are still missing what? We still lack courage and determination. NPL ratio surfaced, and are willing to take, there are a lot of bad recessive financial system and future hidden unemployment, it is impossible to be solved by doing a dream, did not face in 2009, did not face in 2014. Yes, certainly in 2016, 2017 in the face, we expect to see future reforms crucial landing, those of us who have to prepare for thought. iFeng: 中国经济未来三年没有复苏 投资什么最赚钱