Fears about an overheated mainland economy triggering a collapse seem premature at best
Fan Gang 01 March 2010
On the eve of the Lunar New Year, the People’s Bank of China surprised the market by announcing - for the second consecutive time in a month - an increase in the bank’s mandatory reserve ratio by 50 basis points, bringing it to 16.5 per cent. Shortly before that, Beijing acted to stop excessive borrowing by local governments (through local state investment corporations), and to cool feverish regional housing markets by raising the down payment ratio for second house buyers and the capital adequacy ratio for developers.
This latest round of monetary tightening reflects the authorities’ growing concern about liquidity. Last year, M2 money supply (a key indicator used to forecast inflation) increased by 27 per cent year on year, and credit expanded by 34 per cent. Last month, despite strict administrative control of financial credit lines (the People’s Bank actually imposed credit ceilings on commercial banks), bank lending grew at an annual rate of 29 per cent, on top of already strong expansion in the same period a year earlier. While inflation remains low, at 1.5 per cent, it has been rising in recent months. Housing prices have also soared in most major cities.
These factors have inspired some China watchers to regard the country’s economy as a bubble, if not to predict a hard landing this year. But that judgment seems premature, at best.
To be sure, China may have a strong tendency to create bubbles, partly because people in a fast-growing economy become less averse to risk. Thirty years of stable growth without serious crises have made people less aware of the negative consequences of overheating and bubbles. Instead, they are so confident that they often blame the government for not allowing the economy to grow even faster.
Several special factors may make China vulnerable to bubbles. China’s large state sector (which accounts for more than 30 per cent of gross domestic product) is usually careless about losses, owing to the soft budget constraints under which it operates. Local governments are equally careless, often failing to service their debts. In addition, various structural problems - including large and growing income disparities - are causing serious disequilibrium.
But a tendency towards a bubble need not become a reality. The good news is that China’s policymakers are vigilant and prepared to bear down on incipient bubbles - sometimes with unpopular interventions such as the recent monetary moves.
Whatever one thinks of those measures, taking counter-cyclical policy action is almost always better than doing nothing when an economy is overheating. Whereas some policies may be criticised for being too administratively driven and failing to allow market forces to play a sufficient role, they may be the only effective way to deal with China’s administrative entities.
In any case, the new policies should reassure those who fear that Beijing will simply watch the bubble inflate or that it lacks a sufficiently independent macroeconomic policy to intervene. The consequences of burst bubbles in Japan in the 1980s and in the United States last year are powerful reasons why Beijing has acted with such determination, while the legacy of a functioning, centralised system may explain why it has proved capable of doing so decisively. After all, although modern market economics provides a sound framework for policymaking - as mainland bureaucrats are eagerly learning - the idea of a planned economy emerged in the 19th century as a counter-orthodoxy to address market failures.
Some people would prefer China to move to a totally free market, without regulation and management, but the recent crises have reminded everyone that free-market fundamentalism has its drawbacks, too. No one has proved able to eliminate bubbles in economies where markets are allowed to function. But if the fluctuations can be “ironed out”, as economist John Maynard Keynes put it, total economic efficiency can be improved.
Government investment, which represents the major part of China’s anti-crisis stimulus package, should help in this regard. Roughly 80 per cent of the total is going to public infrastructure such as subways, railways and urban projects, which to a great extent should be counted as long-term public goods. As such, they will not fuel a bubble by leading to immediate overcapacity in industry.
Moreover, roughly 40 per cent of the increase in bank credit last year accommodated the fiscal expansion, as projects were started before the budget allocations needed to finance them. Over-borrowing by local government did pose risks to the banking system and the economy as a whole, but given China’s currently low public-debt/GDP ratio (just 24 per cent even after the anti-crisis stimulus), non-performing loans are not a dangerous problem. Indeed, they may be easily absorbed as long as annual GDP growth remains at 8-9 per cent and, most importantly, as long as local government borrowings are contained. Finally, the leverage of financial investments remains very low compared to other countries. Using bank credit to speculate in equity and housing markets is still mostly forbidden. There may be leaks and loopholes in these rules, but firewalls are in place - and are more stringently guarded than ever before.
So is a Chinese bubble still possible? Perhaps. But it has not appeared yet, and it may be adequately contained if it does.
Fan Gang is professor of economics at Beijing University and the Chinese Academy of Social Sciences, director of China’s National Economic Research Institute, secretary general of the China Reform Foundation, and a member of the Monetary Policy Committee of the People’s Bank. Copyright: Project Syndicate
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Chinese bubble-wrap
Fears about an overheated mainland economy triggering a collapse seem premature at best
Fan Gang
01 March 2010
On the eve of the Lunar New Year, the People’s Bank of China surprised the market by announcing - for the second consecutive time in a month - an increase in the bank’s mandatory reserve ratio by 50 basis points, bringing it to 16.5 per cent. Shortly before that, Beijing acted to stop excessive borrowing by local governments (through local state investment corporations), and to cool feverish regional housing markets by raising the down payment ratio for second house buyers and the capital adequacy ratio for developers.
This latest round of monetary tightening reflects the authorities’ growing concern about liquidity. Last year, M2 money supply (a key indicator used to forecast inflation) increased by 27 per cent year on year, and credit expanded by 34 per cent. Last month, despite strict administrative control of financial credit lines (the People’s Bank actually imposed credit ceilings on commercial banks), bank lending grew at an annual rate of 29 per cent, on top of already strong expansion in the same period a year earlier. While inflation remains low, at 1.5 per cent, it has been rising in recent months. Housing prices have also soared in most major cities.
These factors have inspired some China watchers to regard the country’s economy as a bubble, if not to predict a hard landing this year. But that judgment seems premature, at best.
To be sure, China may have a strong tendency to create bubbles, partly because people in a fast-growing economy become less averse to risk. Thirty years of stable growth without serious crises have made people less aware of the negative consequences of overheating and bubbles. Instead, they are so confident that they often blame the government for not allowing the economy to grow even faster.
Several special factors may make China vulnerable to bubbles. China’s large state sector (which accounts for more than 30 per cent of gross domestic product) is usually careless about losses, owing to the soft budget constraints under which it operates. Local governments are equally careless, often failing to service their debts. In addition, various structural problems - including large and growing income disparities - are causing serious disequilibrium.
But a tendency towards a bubble need not become a reality. The good news is that China’s policymakers are vigilant and prepared to bear down on incipient bubbles - sometimes with unpopular interventions such as the recent monetary moves.
Whatever one thinks of those measures, taking counter-cyclical policy action is almost always better than doing nothing when an economy is overheating. Whereas some policies may be criticised for being too administratively driven and failing to allow market forces to play a sufficient role, they may be the only effective way to deal with China’s administrative entities.
In any case, the new policies should reassure those who fear that Beijing will simply watch the bubble inflate or that it lacks a sufficiently independent macroeconomic policy to intervene. The consequences of burst bubbles in Japan in the 1980s and in the United States last year are powerful reasons why Beijing has acted with such determination, while the legacy of a functioning, centralised system may explain why it has proved capable of doing so decisively. After all, although modern market economics provides a sound framework for policymaking - as mainland bureaucrats are eagerly learning - the idea of a planned economy emerged in the 19th century as a counter-orthodoxy to address market failures.
Some people would prefer China to move to a totally free market, without regulation and management, but the recent crises have reminded everyone that free-market fundamentalism has its drawbacks, too. No one has proved able to eliminate bubbles in economies where markets are allowed to function. But if the fluctuations can be “ironed out”, as economist John Maynard Keynes put it, total economic efficiency can be improved.
Government investment, which represents the major part of China’s anti-crisis stimulus package, should help in this regard. Roughly 80 per cent of the total is going to public infrastructure such as subways, railways and urban projects, which to a great extent should be counted as long-term public goods. As such, they will not fuel a bubble by leading to immediate overcapacity in industry.
Moreover, roughly 40 per cent of the increase in bank credit last year accommodated the fiscal expansion, as projects were started before the budget allocations needed to finance them. Over-borrowing by local government did pose risks to the banking system and the economy as a whole, but given China’s currently low public-debt/GDP ratio (just 24 per cent even after the anti-crisis stimulus), non-performing loans are not a dangerous problem. Indeed, they may be easily absorbed as long as annual GDP growth remains at 8-9 per cent and, most importantly, as long as local government borrowings are contained. Finally, the leverage of financial investments remains very low compared to other countries. Using bank credit to speculate in equity and housing markets is still mostly forbidden. There may be leaks and loopholes in these rules, but firewalls are in place - and are more stringently guarded than ever before.
So is a Chinese bubble still possible? Perhaps. But it has not appeared yet, and it may be adequately contained if it does.
Fan Gang is professor of economics at Beijing University and the Chinese Academy of Social Sciences, director of China’s National Economic Research Institute, secretary general of the China Reform Foundation, and a member of the Monetary Policy Committee of the People’s Bank. Copyright: Project Syndicate
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