It is remarkable how the Chinese growth juggernaut has sustained itself over several decades. The country’s achievements are so mind-boggling that they have led strategists to question all presumptions about limits to economic growth.
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The good thing about China’s growth is that it has enabled hundreds of millions of Chinese to break away from poverty. Sustaining the high-velocity growth year after year, however, is not only impossible, but not desirable as well. Even the Chinese authorities recognize that the need for slowing down the brisk expansion of the economy.
Investment bank Lehman Brothers has been raising the flag on Chinese growth since October 2007, after the US housing recession led to a credit crunch in most of the world’s major economies. The bank has since then issued a series of reports, arguing that China’s GDP growth has entered a downtrend and that the latent overcapacity problem in China’s economy is likely to be exposed as a result.
“Although overcapacity may not seem a serious problem at the moment, we judge that it will become evident in the second half of 2008 when exports start to slow down, potentially triggering a chain reaction in the economy and the financial system that could last up to 2009,” says Lehman Brothers’ analyst Sun Mingchun in a report issued in early May 2008. This is the reason, she says, why Lehman has lowered China’s GDP growth forecast for 2009 from 8.5% to 8.0%.
In her report, Mingchun has decried the lopsided development that the country has pursued for the last three decades, favouring domestic investments instead of consumption. This, she contends, has resulted in the country accumulating too much capacity, which will not be of much use in a world that is starting to feel the impact of a major recession in the US and slowing demand from Europe and elsewhere.
She points out that fixed capital formation has grown by more than 10% in 24 of the past 30 years and has consistently exceeded consumption growth since 2000. “As a result, there has been serious over-investment, with China accumulating production capacities far exceeding domestic demand in many sectors.”
She recounts that in March 2006, the National Development and Reform Commission (NDRC) listed ten sectors where there was perceived overcapacity. “Judging from the 2006 utilization rate, however, overcapacity was not particularly alarming in some of these areas.” A key reason for the discrepancy is that the NDRC has taken measures to shut down production facilities gradually to ease the supply glut.
For example, between the second half of 2005 and the first half of 2007, more than 8,000 small coal mines were closed, which explains the 105% utilization rate in coal production capacity in 2006.
Premier Wen Jiabao, in his report to the National People’s Congress in March 2008, said the government had also closed 8.5% of iron production capacity, 6.6% of steel, 4.6% of cement and 3.0% of power generation capacity. Those measures have eased the supply glut in these sectors, raising utilization rate.
Sun says that with so much latent overcapacity, an export slowdown could trigger a chain reaction, “that in turn could threaten the stability of China’s financial and economic system.” This potential economic fallout, says Sun, could start happening in the third quarter of this year. “As external demand weakens, inventories are likely to pile up. To get rid of excess inventory, exporters are likely to engage in fiercer price competition, despite rising production costs.”
She anticipates a chain reaction where bankruptcy numbers rise, industrial shutdowns become common, unemployment queues get longer and confidence in stock markets take a dive.
“The unmasking of overcapacity would likely have a second-round ripple effect on the economy that could conceivably lead to social and political issues if the government does not take proper and timely action,” Sun warns, her report weaving a 10-page tale of gradual economic implosion that is a helpful reality check these days, especially when what one hears most often these days is the talk about the loud roar of the Chinese dragon.
– Rodney Diola
