Michael Pettis,”Bad loans could take their toll on China’s growth”

Bad loans could take their toll on China’s growth, Financial Times

By Michael Pettis

Published: April 21 2010 22:54 | Last updated: April 21 2010 22:54

Will China have a banking crisis? Beijing’s massive credit stimulus will almost certainly lead to a future surge in bad loans, but so what? As the more optimistic of China analysts have pointed out many times, the last jump in non-performing loans a decade ago was also widely cited as a sign of impending doom, and yet nothing happened. China grew its way out of the loan mess at little apparent cost.

But did it? The optimists have almost certainly failed to understand how Beijing paid for its earlier banking crises. In fact, the cost of resolving the previous surges in non-performing loans exacerbated China’s domestic imbalances. The current build-up of bad debt may very well do the same.

Beijing used three main tools to manage previous increases in bad loans, all of which passed costs on to bank depositors. First, the central bank slowed the accumulation of non-performing loans by keeping lending rates low. Low borrowing costs made it easier for struggling businesses to roll over the debt as the economy grew and reduced the real value of debt payments.

Second, policymakers infused the banks with additional equity, partly directly and partly by purchasing bad loans at above their liquidation value. They financed these capital infusions by borrowing, which at artificially low rates has the effect of passing the repayment burden on to lenders. Finally and most importantly, the central bank mandated a wide spread between the bank lending and the deposit rate, which increased the profitability of banks substantially and so helped to recapitalise them.

Beijing’s strategy was very successful and certainly prevented a banking crisis, but there was nonetheless a cost. The bail-out implicitly required that bank depositors subsidise the cleaning up of the banking industry. This in effect represented a large transfer of income from the household sector to the banks, to government and to businesses. It is perhaps not surprising, then, that during the period of the bail-out household income, already a relatively low share of gross domestic product, declined to alarming levels.

This is the real risk of rising non-performing loans in China. It is not that China’s banks are likely to collapse. Debt levels are certainly high and highly pro-cyclical – normally a toxic combination – but Beijing largely controls domestic funding and can protect itself from the bank runs that plagued the US and Europe. Like Tokyo in the 1990s, Beijing is in a strong position to continue to fund its rising bank-related liabilities and will not have a debt problem any time soon.

The danger is that the cost of cleaning up the banking system will fall, as in the past, on the household sector. China must reduce its excessive reliance on exports and investment to fuel its continued growth, and the only way that can happen is if household consumption rises as a share of GDP. But since growth in household consumption has always been constrained by growth in household income, it may be unreasonable to expect a surge in consumption when households are also required to clean up a sharp increase in bad loans.

Over the next few years, as trade tensions increase and the world finds it increasingly difficult to absorb China’s rising capacity, the country’s growth will rely more than ever on the growth of household consumption. If the worriers are right and non-performing loans surge, China can nonetheless easily avoid a banking collapse. But that does not mean the cost of cleaning up the banks will be negligible. On the contrary, it will put even more pressure on low-consuming Chinese households and will make the inevitable rebalancing of China’s economy much more difficult than many expect.

Japan showed how difficult. Since 1990 Japanese consumption growth has limped along at between 1 and 2 per cent annually as households have been forced indirectly to clean up their own bad loans. The economy grew much more slowly. Just as Japan slowly rebalanced its economy towards consumption, so must China.

If future Chinese consumption growth also slows because households are forced to foot the new bad-debt bill, we may see the real cost of the current explosion in bad loans – several years of sub-par growth.

The writer is a finance professor at Peking University and a senior associate at the Carnegie Endowment

http://www.ft.com/cms/s/0/9d2a0448-4d77-11df-9560-00144feab49a.html

David Pilling, “Reason vs emotion in China’s growth story”

Reason vs emotion in China’s growth story, Financial Times

By David Pilling

Published: January 20 2010 22:23 | Last updated: January 20 2010 22:23

Sarah O’Connor and Frances Williams, “Beijing can launch new stimulus, says IMF”

Beijing can launch new stimulus, says IMF

By Sarah O’Connor in Washington and Frances Williams in Geneva

Published: July 22 2009 18:04 | Last updated: July 23 2009 01:27

http://www.ft.com/cms/s/0/6072aede-76da-11de-b23c-00144feabdc0.html

China has room to launch another stimulus aimed at increasing domestic consumption and swinging the economy away from its dependence on exports, the International Monetary Fund said on Wednesday.

The report came even as the World Trade Organisation said China was set to overtake Germany as the largest goods exporter this year, underlining what many economists see as the need for China to export less and consume more.

In a long-delayed assessment of China’s economy, the IMF report praised the country’s efforts to stimulate its economy. But it added that, given the low level of public debt, it saw “further room for a targeted, additional stimulus aimed at increasing private consumption through near-term fiscal measures to raise household income”.

The IMF’s executive directors suggested reforms to healthcare, education and pension systems which would make people feel better about saving less and spending more.

It also said unemployment would probably rise as China tried to rebalance the economy and jobs were lost in export sectors. However “over a longer horizon, the employment gains from rebalancing towards domestic consumption and an increase in service sector employment should outweigh short-term losses”.

The economic assessment is meant to be issued annually but had been blocked by China until now over fears about how the IMF would label its currency, which some complain is kept unfairly low to make exports more competitive.

IMF directors were divided over that issue, according to the report. Some thought the renminbi remained “substantially undervalued” and should be strengthened as part of a “comprehensive strategy to rebalance the economy”. Others said it was difficult to make exchange rate assessments and the currency would only play a “supplementary role”.

The issue is a source of constant friction between the US and China, and is likely to be raised next week when top officials from the two countries meet in Washington for a “strategic and economic dialogue”. Some US lawmakers want to put sanctions on Chinese goods because of its currency policy, but the Obama administration has backed away from confrontation.

International financial institutions expect China to reap quicker trade benefits from a global upturn later this year that will be led by emerging economies.

“Our figures showed that Asian countries may be leading a recovery in global trade,” Pascal Lamy, WTO director-general, told reporters in Singapore at a meeting of trade ministers of the Asia-Pacific Economic Co-operation forum.

Last year, China’s merchandise exports of $1,428bn (€1,004bn, £869bn) were only slightly behind Germany’s $1,465bn, according to the WTO report.

Meanwhile, China, which notched up year-on-year growth of nearly 8 per cent in the second quarter, remains the top destination for future foreign direct investment (FDI), according to a survey by the United Nations Conference on Trade and Development released on Wednesday. The 240 multinationals that responded to the questionnaire put the US in second place, followed by India, Brazil and Russia.

Copyright The Financial Times Limited 2009

Also see:

IMF Executive Board Concludes 2009 Article IV Consultation with the People’s Republic of China July 22, 2009

“Geithner’s good start in Beijing,” Financial Times

Geithner’s good start in Beijing, Financial Times Editorial

Published: June 1 2009 20:06 | Last updated: June 1 2009 20:06

The US and China are locked in a teetering dance, each grudgingly matching one another’s first steps. This week, in a speech at the start of his visit to Beijing, Tim Geithner, US Treasury secretary, set out a plan for how this relationship can develop into a more graceful arrangement. Mending the world economy, however, must go beyond mere bilateral talks.

Mr Geithner’s speech was geared towards both US and Chinese audiences. He sent a reassuring message to China, the largest buyer of US government debt, about his plans to cut the fiscal deficit. By setting out his stall first, the Treasury secretary managed to avoid the impression of being an incorrigible wastrel, summoned to see his suspicious bank manager.

Mr Geithner also noted that China needed to change its economic model. Beijing does need to move away from its export-orientation. But, by acknowledging that the US is equally responsible for the world’s economic imbalances, he made his case without upsetting his hosts. This was no mean feat.

In the run-up to the crisis, Chinese strip mills fed American strip malls. Chinese savings financed American consumption. In the future, the US must save more and the Chinese people must create more final demand.

This is easier said than done. If China stops financing the US deficit or US consumers stop spending too rapidly, the crisis will enter a new, darker chapter. In the longer term, making China less parsimonious and the US less voracious means re-engineering both economies. Re-establishing habits of thrift in America will be painful; no one wants to cut consumption.

Chinese demand is limited by workers’ income, which is a mere 40 per cent of national output. Demand also suffers because, lacking a robust social security system, Chinese consumers save up as insurance against illness and unemployment. Building a social safety net and redistributing money from Chinese corporations to workers would mark a generational shift with serious consequences for the elite.

In the short term, China and the US can do only so much. The G2 is the world’s most important bilateral relationship; it accounts for 31 per cent of world output and a quarter of its trade. While their relationship is crucial, the world cannot be brought back into kilter by these two Goliaths on their own. Global economics is a multilateral affair today, a dance with several partners. Mr Geithner and his hosts should bear that in mind.

http://www.ft.com/cms/s/0/10adcf3c-4ed5-11de-8c10-00144feabdc0.html

Copyright The Financial Times Limited 2009

Michael Phillips, “U.S. to Urge China to Shop, Not Save”

U.S. to Urge China to Shop, Not Save, Wall Street Journal

By Michael Phillips

May 29, 2009

WASHINGTON — Treasury Secretary Timothy Geithner heads to Beijing this weekend to urge Chinese leaders to fundamentally alter the export-oriented economy that has created years of trans-Pacific trade tensions.

In meetings with Chinese President Hu Jintao and Premier Wen Jiabao, Mr. Geithner is expected to reiterate U.S. support — and gratitude — for the giant stimulus package that China has implemented to combat the global recession.

But he is also planning to press Beijing to take drastic measures to turn China’s economy into one that depends heavily on sales to domestic consumers and less on sales to the U.S. and other foreign markets, according to a senior Treasury Department official.

That means encouraging Beijing to offer more generous health-care, retirement, welfare, educational and other benefits in order to persuade the average Chinese citizen that spending now doesn’t mean starving later.

“The efforts China could take would be efforts to strengthen the comfort that Chinese households have in spending, which largely involves reducing or addressing the reasons why they feel such a great need to save for precautionary purposes,” said the senior Treasury official, who briefed reporters Thursday in advance of Mr. Geithner’s departure on Saturday.

The message signals that Treasury is beginning to look beyond the current crisis toward preventing a return to ever-mounting trade deficits and the constant political tensions they generate between the U.S. and China.

Mr. Geithner has been heartened by the fact that China’s two-year, four trillion yuan package — nearly $600 billion — of government and corporate spending includes components to encourage a buying spree by Chinese consumers.

The government has compelled state-run banks to unleash a flood of credit, lending more in the first four months of this year than in all of 2008. And officials have announced a series of subsidies and other measures to encourage rural dwellers to splurge on such items as small-engine cars, home appliances and electronics.

“There is certainly discussion about the importance of shifting towards a more balanced, more domestic-demand source of growth for assuring Chinese growth in the future,” the Treasury official said, noting that the Chinese have included that goal in their five-year plan.

That will also require, in the U.S. view, allowing China’s currency to move more freely against the dollar. But Mr. Geithner is unlikely to hector Beijing about the yuan very much during this visit.

The issue has long been a sensitive one, with U.S. manufacturers and their political allies accusing China of manipulating its currency to get an unfair edge in foreign trade.

Earlier this year during his confirmation process, Mr. Geithner labeled the country a currency manipulator, although the administration later backtracked and played down the comments.

The U.S., on a borrowing binge to restart the economy, needs China to continue to purchase dollar assets. Yet Chinese officials have, in recent months, expressed concern that big U.S. budget deficits and the threat of inflation might eat away at the value of their dollar holdings.

So far, however, Beijing hasn’t pulled back from investments in U.S. government securities, something the Obama administration wants to avoid.

The trip is Mr. Geithner’s first to China as Treasury secretary and an important step in resuming the dialogue pursued by his predecessor Henry Paulson.

The trip is intended to lay the groundwork for a broader Strategic and Economic Dialogue meeting in Washington this summer in which Mr. Geithner will lead the U.S. side of economic talks, while Secretary of State Hillary Clinton will head up the political and strategic discussions.

Mr. Geithner is scheduled to arrive in Beijing on Sunday for meetings Monday and Tuesday.

—Andrew Browne in Beijing and Jason Dean in Singapore contributed to this article.

http://online.wsj.com/article/SB124352913219063157.html

Krishna Guha, “US to reassure China on fiscal discipline”

US to reassure China on fiscal discipline, Financial Times

By Krishna Guha in Washington

Published: May 29 2009 00:12 | Last updated: May 29 2009 00:12

US Treasury Secretary Tim Geithner will reassure Chinese leaders that the US is commited to long-term fiscal discipline on his trip next week to Beijing, a senior Treasury official said on Thursday.

Mr Geithner will also urge his hosts to accelerate moves to shift the composition of China’s economy, so it relies less on exports and more on domestic demand, the official added.

His comments came amid heightened concern in US markets about China’s continued appetite for US government bonds and other assets and anxiety in China about potential losses on its US investments.

Richard Fisher, the president of the Dallas Fed, on Thursday challenged the view that foreign central banks are shying away from longer duration Treasuries, saying “there continues to be strong demand”.

But he highlighted the severe fiscal challenges facing the administration – including what he estimated was $104,000bn in unfunded entitlement liabilities – and said the US central bank “can ill-afford to be perceived as monetising debt”.

Mr Geithner will describe the required rise in US national savings and growth in Chinese consumption as two sides of the same coin, both required to rebalance the global economy once the crisis is over.

The aim is to lay the foundations post-crisis of “more balanced, more sustainable global growth,” the official said.

He said Mr Geithner would also praise China for its contribution to supporting global demand during the crisis – including the world’s second biggest fiscal stimulus – and urge the Beijing leadership to continue these efforts.

Notably, the official did not highlight China’s currency as a top issue for the talks, even though the US continues to see Chinese currency reform as necessary to accomplish the required rebalancing and expects some discussion of currency issues.

The mix of issues reflects the shifting relationship between the two countries, which remain heavily reliant on each other for trade and financing.

The senior Treasury official said Mr Geithner will argue that for the US, global rebalancing means “laying out a path to bring down the fiscal deficit” while also making investments in health, infrastructure and energy to increase productivity.

“The US household savings rate has already risen, will probably continue to rise and the fiscal deficit will come down,” he said.

For China, as well as a number of other economies, it would mean boosting domestic demand so these nations are less reliant on US consumption for growth.

The US Treasury Secretary will urge China to increase spending on health, education and pensions, to reduce the need for precautionary saving, increase credit availability and boost household incomes.

http://www.ft.com/cms/s/0/88726e62-4bdb-11de-b827-00144feabdc0,dwp_uuid=9c33700c-4c86-11da-89df-0000779e2340.html?nclick_check=1