Fixed Asset Growth Reveals Structural Reform
Challenges
China's economy grew by 9.7 percent based on GDP, over
the same period one year ago, while exports went up 34
percent. Growth was heavily unbalanced, with investment
in fixed assets going up 43 percent, raising concerns
that the Chinese economy is setting the stage for an asset
bubble.
The uncontrolled growth in fixed assets reveals the inability
of China's central government to control lending and spending
on the provincial government level. In spite of repeated
warnings from the central government and the China Banking
Regulatory Commission, provincial governments continue
to pressure the state-owned banks to lend money to inefficient
state-owned enterprises, raising instead of decreasing
China's bad loan portfolio. Most of these companies are
only profitable because of heavy domestic demand; without
it, most would not survive.
This system of high provincial spending autonomy is a
legacy from China's early days of reform in the early
eighties, when Deng Xiaoping gave authority to provincial
governments to make their own investment decisions. At
the time, Deng's goal was for them to take responsibility
for their own business and investment decisions. The problem
was that the banking system they all tapped into was the
state-owned four leading banks. The system has now become
twisted, and provincial governments have become involved
in their own business groups, tapping the provincial branches
of the banks as their sources of capital.
Once the capital reaches the provincial level, Beijing
has no control over lending decisions. Since many investments
are large, fixed asset projects which have already had
a large amount of debt on their hands, the provincial
governments continue to lend to these projects, giving
them basically free money.
A major component of this mix is the large amount of
capital entering the country as "hot money"
and which is going into real estate amid expectations
that the Chinese yuan will be revalued upwards against
the dollar.
The China Banking Regulatory Commission has issued warnings
about lending to certain hot sectors, but they don't have
the teeth to rein in the lending. Now the question is
reaching the point where the government of Premier Wen
Jiabao will have to bite the bullet. The question is how
this will be achieved.
There is a Chinese saying shaji jinghou, which
means that is sometimes necessary to kill a chicken in
order to scare the monkeys into line.
That time has come.
If the premier does not address this issue now, all his
efforts to reduce
the bad loan portfolios of the leading banks will
be futile, because new bad loans will be piled on faster
than they can sell off old bad loans.
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