TIOL - COB( WEB) - 935
AUGUST 29, 2024

By Shailendra Kumar, Founder Editor

THE Chinese economy is going through a tear-jerker phase! The larger question before seasoned economists, worldwide, is - Will China manage to get out of this quicksand or would continue to race down the hill? Though it may appear to be a trillion-dollar question, and many economists may prefer to stick their neck out to back China's much-famed resilience to bounce back, but I would risk taking a contrarian view, based on an eyeful of macro-economic datasets! Before I dwell on an assortment of these 'puncturing' parameters, let me first highlight how 'Zero COVID' policy broke many spokes in the wheel of its Godzilla industrial machine! As a result, its recovery has faltered - sluggish GDP figures; sagging consumer demand; carcinomatous property crisis, accelerated pace of bankruptcy; local governments going almost-insolvent, and frequent trade and technology-related bickering with the West.

To top it all, the virtue of 'structural overcapacity' has turned into poisonous chalice! What seems more bizarre is the stubborn faith of the Beijing bureaucracy in its historic industrial policy - the key driver of overproduction. The prevailing view of the Xi Jinping government is that consumption is an individualistic distraction or choice - Abracadabra!, policy intervention not needed! And such a view was further reaffirmed by the recently-held third plenum where party officials quelled temptations to giddy up consumption, resulting in deflation of consumer prices in the economy! Interestingly, prices of consumer goods are presently under 'guerrilla' attack from all sides - slippage in income, scary joblessness, rise in insolvency, smouldering debt problem and embarrassingly excess production of industrial goods!

Quite weird but the ground reality is that the domestic market has been convulsing for lack of demand since the pandemic years. And this has been a strong tailwind behind ferocious competition in the domestic market, which, in turn, further roils the falling prices of a wide range of goods. Though competition is globally construed as a powerful instrument to benefit consumers, but since consumers are, eek, not keen on dialling up their spending, this further nudges manufacturers to look towards export markets - yet another factor contributing to the globally-loathed phenomenon of overproduction by China. Common consumers' confidence has suffered a serious dent ever since the property crisis popped up on the horizon in 2021. They had invested their life-time savings to purchase flats but the behemoths in the real estate sector have worryingly been going bankrupt owing to their unmanageable debt burdens.

What adds to their buckets of woes is the decision of the Xi Jinping government, not to bail them out by permitting banks to give them fresh credit! But why? A vast landscape of ghost towns has not perturbed the Chinese President Xi Jinping as his economic priority has changed owing to inflammation in China's relations with the West! The real estate sector, a few years back, used to be a priority sector for the government. And, indeed, it contributed substantially to the annual growth trajectory - about one-third. Unfortunately, most developers amassed cheap loans, more than they could really service! Secondly, they could not contain their horrible impulses to divert funds to other ventures! And soon came a time when their revenue receipts began falling short of the sum required to service debts. Evergrande, China's largest developer, is just one case. Interestingly, it had also diverted its capital to take a deep dive into the galloping market of electric vehicle (EV) but two of its subsidiaries have also recently filed bankruptcy petitions like its parent company.

Quite predictably, the glut in industrial production has been killing too many firms in almost all the sectors. It is not limited to property and EV markets only. Since last year, at least eight large car-manufacturers have downed their shutters. And the ripple effect has been recorded throughout the supply chain. As many as 52000 such EV-related parts-manufacturers have folded up their operations in 2023. The number of loss-making firms has taken a massive leap. As per China's National Bureau of Statistics, over 30% of industrial firms have turned loss-making. Its survey of over five lakh firms has revealed serious erosion of their financial health in the first half of 2024. China's solar industry, like the EVs, is the first to run into a pickle. The prices of most components of solar modules have nosedived below the average production cost! Hundreds of firms have begun scaling back their output. Similarly, thanks to excessive investments into the making of low-end chip components, there has been huge oversupply, leading to regular failing of such firms. More than 10,000 such firms exited the business in 2023. A similar tale is repeated in the case of lithium-ion batteries. The story of steel and aluminium is no different. China produces more steel than EU, Japan and the US put together!

So, what is the mystery behind China's rosy assumption? Why have China's economic planners repeatedly goofed up? Why are they not using economic tool-kits to correct the festering distortions in the economy? Let's lope back into its economic history. China has consistently pursued an economic model in which the CCP and the Beijing leadership decide on industrial priority sectors and local governments fire all cylinders to make investments in these pre-decided sectors. The federal government allocates resources and also directs all banks to work closely with the local governments. Those who excel and manage to outgrow and outsmart others of their ilk, are not only praised but also rewarded in many ways such as higher ranks in the party and also financial spigots. Since all the provinces compete against each other by raising funds by selling their land stocks and borrowings from state-owned banks, the notified priority sectors take long strides and evolve into behemoths in a few years' time. That is how Chinese critical sectors like infrastructure, steel, critical minerals, EVs, solar modules, low-end chips and lithium-ion batteries, have grown in the recent decades. It is indeed an exemplary ladder to climb the peak of production in a particular sector but it also suffers from two devastating inherent flaws - duplication of investments and soaring debts.

Since all the provinces roll out investments in the Beijing-notified priority sectors, it not only leads to wrong-footed and lop-sided allocation of resources but also creates excess capacity for oversupply. A crystal-clear case of structural overcapacity at the cost of other sectors and also domestic demand. Beijing is so much obsessed with the buzzwords like self-sufficiency and industrial production that it does not know where to stop? Although it has come under heavy-fire from the West for overproduction and dumping of goods in the global markets and harming the industrial base of other economies but Mr Jinping seems to be driving a car without a brake - sashaying away to glory! Take the example of solar panels. Beijing decided that this sector should account for 15% of GDP by 2020, and within a few years, about 98 cities had set up solar-PV industrial parks and its output left behind domestic demand by miles. The excess supply was exported. By 2022, it attained so much of installed capacity that its own electric grid could not take the load of additional capacity. This led to dumping of goods in the global markets, inviting the ire of many countries imposing countervailing duty. Today, China's capacity is double the global demand and has begun eating into the financial health of hundreds of companies. What a conundrum! A good number of companies have been exporting their output at a price below the production cost but none expects any tears from the Beijing bureaucracy! Given the generous subsidies and other benefits from the State agencies, a good number have managed to stay afloat but an equally large number have also died a cyclical death, adding to the surging curve of insolvency. One will find similar stories coming from other sectors like EVs, steel, lithium-ion batteries and many more.

Another spin-off of such a recalcitrant and skewed policy approach is the soaring quantum of overall debts of the Chinese economy. A large number of firms, albeit generously supported by the local governments, have been regularly shutting down under the burden of crippling debts. As per one estimate, overall off-balance sheet debts of the local governments lie between USD 8 trillion to USD 10 trillion - close to USD one trillion about to default. Take the case of China Railway which runs a record number of bullet trains and has many records to its name for creating awe-inspiring bridges and other infrastructure-base, but also runs a debt of USD 859 billion. A large swathe of its railway stations is unused and tracks are under-utilised! What has boomeranged for it is its recent decision to hike fares - more passengers avoiding use of high-speed railways and its debts continue to balloon! The top-down approach of Beijing to reward local officials for making investments in Mr Jinping's priority sectors has not only led to crushing debts but also created industrial overcapacity! Mounting debts have buffeted many of Chinese property sector players. Evergrande owes about USD 174 billion external debt. The overall property sector debt is estimated to be about USD 5.4 trillion. Its corporate debt has jumped close to almost three times of such debts in advance economies.

The lesson to be learnt by the Global South economies is that loans in themselves are not bad but cheap loans backed by governments in terms of low interest and mammoth subsidies tend to devour the basic canons of a healthy business. Unbridled credits, at one stage, turn into cannonballs for the economy and the predictable consequences are structural oversupply, deflationary trap and geopolitical sparring. Indeed, the shelf-life of the Beijing-backed priority sector-approach is nearing an end, and so will soon end the era of cheap exports by China! Even if a good chunk of the Global South countries may greet cheap Chinese goods with red carpet, the phenomenon of creating 'Zombie' companies would certainly alter the dogma-riding economic planning approach! It is our way or the highway philosophy may work in an autocratic political environment but not in transactional economy, integrated into a global system! Rigidity in economic philosophy promises just one highway ahead which goes down the hill! China is on a dangerous trek, indeed! Voila!