Introduction
The Shanghai Composite Index soared 150 per cent over the past year before shedding 30 per cent in a little more than three trading weeks[i]. For a world concerned about Greece, it was another plausible jolt. The hawks predicted death of the Chinese economy. Rest were a little more circumspect, explaining it as a routine bull-bear cycle of a stock market, the flip side of which was that they ignored the market surge even while economic growth diminished – an unsustainable situation in any economy. Amongst the various arguments the rollercoaster has exposed chinks in the Chinese economy, uncontrolled, which can adversely affect their society and the neighbourhood in turn.
China’s Economy
Experts believe that stock market returns are a strong predictor of GDP growth[ii] and its macro trend contextually to the economy and its role therein needs understanding. In brief, markets rise when money flows in and fall when it flows out. The aspirations and fears which cause this in/out flow therefore need to be understood.
Social instability in China, unless controlled, potentially can overthrow regimes and fragment China[iii]. The present regime has tried to maintain it through 100 per cent employment, low inflation[iv] and control over the Armed Forces. The three are thus critical for a stable China.
To maintain full employment China needs to create roughly 10 to 12 million[v] new jobs annually. It is estimated that a minimum 7 per cent annual growth is required for China to create 10 million jobs and, its tolerance below 6.5 per cent levels is questionable[vi].
Economically, China essentially follows what is called the East Asian Model. Plagued with high population densities and labour intensive agriculture, these societies have suffered unrest due to governmental failure to maintain employment. Hence, governments’ have aimed at harnessing savings and controlling the financial systems to ensure credit expansion for infrastructure, industrial capacity expansion and becoming export-oriented manufacturers[vii]. The problem is that the model discourages development of domestic consumption[viii]. Therefore during recession in view of weak demand, increased investments become unsustainable. Such recessionary phases hence require a transition to stabilise and boost domestic consumption while allowing tapering off of fixed investments.
China too has an export economy, in need of such a transition. For long, investment and exports drove the economy[ix]. It was thus dependent upon the world's willingness to buy, a direct outcome of price differential due to its low wages and interest rates[x]. The world economic slowdown and rise of wages in China led to decreased exports. China thus needs to boost its domestic consumption. This requires a raise of average incomes making non-essential purchases feasible and instilling a sense of financial security to convince people to spend[xi]. The options to achieve this are either a ‘rise in wages’ and/or ‘interest rates on savings’ or ‘investment opportunities’. As the former undermines its exports, China chose the latter – specifically real estate and stock markets[xii]. Stock markets further gained importance due to the protracted decline[xiii] in real estate.
Non-Performing Assets (NPAs)
The above has occurred in the backdrop of rising NPAs in its banking system. The investment-led growth strategy of China has implied that each downturn has been confronted with increased investment. Apart from government revenues, banks were encouraged to lend to companies, especially state owned enterprises (SOE's)[xiv] – who made little attempts to improve efficiency. This increased the risk of loan default. When NPA's of Chinese banks became untenable, these were removed from the banks’ balance sheets and placed in special firms called Asset Management Corporations (AMCs). This allowed banks’ balance sheets to be cleaned and raising of new funds by them.
The AMCs were supposed to recover the loans by 2009; however, the actual recovery was limited to 22.4 per cent[xv]. Hence, in 2009 the debt was rolled over for another 10 years. Around the same time faced with another financial crisis, credit was again increased. A S&P study[xvi] estimates that NPAs in Chinese Banking Sector alone would be RMB 2.7 trillion in addition to more than RMB 3.5 trillion held with the AMCs[xvii]. This works out to 5.6 per cent of the total Chinese economy[xviii]. Controlling this starves the small and medium enterprises of capital, even whence there is no dearth of liquidity[xix], thereby affecting their employment generation capability.
Majority of these debts are likely to come up for repayment around 2019. While Beijing holds large FOREX reserves using these to repay local debt would imply their conversion to local currency which in turn would lead to an increase in money supply and consequently inflation.
Acknowledging the need to curb wasteful state-led investment, reducing the state-sector's reliance on cheap financing and improving the ability of banks to price risk[xx], the CCP in its 2013 conclave, declared that it would let market forces play a decisive role in allocating resources[xxi]. Hence, the government promoted the stock surge with an aim to boost local consumption, make private capital available for industry and also reduce NPAs[xxii]. Hence, even though it is small by world standards[xxiii], a bear run in its stock market can harm the Chinese economy by hampering attempts to increase domestic consumption. In turn it adversely affects inflation and capacity to generate employment – either of which can lead to social unrest.
That Beijing is sensitive to the issue can be garnered from the large number of steps it has taken to try and stem the fall. Interestingly, what is different from the rest of the world is that the interventions are directly into the markets with little effort to address the underlying causes. These include: -
(b) Loosen restrictions on margin loans[xxvi].
(c) Government backed purchases - $19.4 billion funds from Brokerage Association in addition to Sovereign Wealth fund and pension fund purchases[xxvii].
(d) Buyback of shares by SOEs[xxviii].
(e) Investigate potential market manipulation and speculators[xxix].
(f) Prosecute those spreading rumours[xxx].
(g) Halt trades on many counters[xxxi].
(h) Suspend IPOs[xxxii].
Social Unrest
Gini coefficient is commonly used as a measure of inequality of income or wealth[xxxiii]. It is believed by Social Scientists that a Gini coefficient higher than 0.4 and inching towards 0.5 can lead to social unrest and above 0.5 a major social upheaval may follow.
Data released by China’s National Bureau of Statistics in the third week of Jan 2014 suggested that the Gini coefficient for 2012 was 0.474[xxxiv] up from 0.4248 in 2005 and 0.355 in 1993[xxxv]. The data supports the fact that reportedly between 1993 and 2005 – 4,19,700 incidents of mass disturbances[xxxvi] were reported whence the coefficient rose from 0.355 to 0.4248. It also implies that this trend of mass disturbances would increase as it has worsened further. The high inequity combined with inability to generate adequate employment and inflation would aggravate such disturbances.
Social unrest in China has often been quelled by the PLA. President Xi Jinping in a speech in Dec 12 said ‘the lesson for China from the disintegration of the Soviet Union is that we must stand firm on the Party’s leadership over the military’[xxxvii]. His statement[xxxviii] is a clear indicator that the Chinese leadership wants to retain complete control of the party on the PLA as also use it to quell unrest. Any increase in social unrest would hence lead to an increased importance for the PLA.
In the run up to 2017-18, when the new politburo and politburo standing committee are to be elected, PLA leaders would try to correct the imbalance of their representation[xxxix]. Its increased importance by maintaining social stability caused due to a government sponsored economic transition, would translate into a higher assertiveness of PLA leaders focused on achieving their goals. This would not bode well for the neighbourhood. The threat of increased inflation due to repayment of debts in 2019 would make the situation even worst.
Implications
China cannot afford a simultaneous protracted downturn in real estate and/or stock markets. It would hence, continue to intervene and prop up either one or both of these.
While China is unlikely to be next Greece and collapse, the world has to closely watch for a drop in growth and consequent increase in inflation and/or unemployment. This would only lead to a more assertive PLA.
Conclusion
The Chinese dilemma is that the factors which are causing social unrest are actually the drivers of its economic growth. In a period of economic slowdown, attempts to increase the growth leads to increased unrest while attempts otherwise leads to job losses. Whether the outflow of money from the stock market and the consequent fall in indices reflects concerns about the economy or not, they certainly reflect the economic dilemma of the economy. This has been highlighted by the government intervention. Growth, inflation and unemployment would be key features to watch as they can contribute to rise in unrest and a consequently a more assertive PLA to the discomfort of the neighbours.
End Notes
[iii] Since the time of the Zhou Dynasty the Chinese rulers invoked the concept of the Mandate of Heaven to legitimize their rule. It was believed that a ruler had lost the Mandate of Heaven when natural disasters occurred in great number, and when, more realistically, the sovereign had apparently lost his concern for the people. In response, the royal house would be overthrown, and a new house would rule, having been granted the Mandate of Heaven. Traditionally, rulers were judged by their concern for or indifference towards the people. Government by Virtue and Social harmony were key components of the idea. By implication if a ruler was out of sync with the heavens, then chaos in society was sure to follow. What was feared most in this system was instability and chaos. Instability was the result of any number of factors, including famine, invasion, unfair conscription of labourers and troops, over-taxation, and incompetent, corrupt, or malicious rulers. When conditions become unstable, popular uprisings can result that may prove difficult or impossible to quell. For a detailed discussion of the issue, please see the author’s book ‘China’s Geo-Strategy and International Behaviour’ published through USI by Vij Books.
[iv] After initial opening up in 1979 there have been three major inflationary bouts - 1985 when inflation touched 10%, 1988-89 when it touched nearly 20% and 1993-96 when inflationary pressure touched 25%. Each of these was economically and socially disruptive period the eighties leading to Tiananmen while the nineties leading to shedding of 30 million workers between 1996 – 2000 (See Albert Keidel Senior Associate, Carnegie Endowment for International Peace in his paper ‘China’s Social Unrest: The Story Behind the Stories’). Presently while threat of a runaway inflation is minimal concerns persist over price spikes in critical areas whipping up social unrest.
[v] https://books.google.co.in/books?id=Zoouvv_4QfUC&pg=PA208&lpg=PA208&dq=number+of+new+job+entrants+every+year+in+china&source=bl&ots=kuS76t9kD-&sig=lYfLyYKd1hJH9MHjevrOqyuuKhI&hl=en&sa=X&ei=HcKeVMKZE4uuuQSHroLgCQ&ved=0CCcQ6AEwAg#v=onepage&q=number%20of%20new%20job%20entrants%20every%20year%20in%20china&f=false
[vi] Wharton Business School Report ‘How China’s Economy Can Weather a Long, Slow Fall’http://knowledge.wharton.upenn.edu/article/chinas-economy-can-weather-long-slow-fall/
[vii] It was also defined as state-led investment in commanding sectors for growth and was export-driven. Seehttp://www.c3sindia.org/economyandtrade/3695
[viii] GDP – the measure of growth – is by definition the sum of consumption, investment, net exports and government spending and is an essential component to study the growth structure of an economy. See http://en.wikipedia.org/wiki/Gross_domestic_product.
[ix] K.Subaramanian ‘China: External Economic and Financial Relations under the New Leadership’http://www.c3sindia.org/india/3456
[xi] Ibid
[xii] Ibid
[xiii] Ibid
[xiv] The overall scheme was to fund plan programs to promote growth. Bank deposits were diverted for funding them. They were channeled through Development Banks. The National Development Reform Commission vetted the disbursements, which is comparable to our Planning Commission. There are administrative procedures to evaluate the cost effectiveness and sustainability of loans/projects. The Communist Party of China (CPC) and the government keep pressure on the SOEs to fund ongoing projects and also to open new operations in new areas. Credit plans are drawn up in accord with Plan priorities and become the basis for bank lending. In the earlier years, the control was rigid. However, over the years, it has turned into what is called “window guidance.” Counties and Town and Village Enterprises (TVEs) are also associated with the process. This has provided great flexibility and dynamism to project funding and to growth. There is intense competition among Counties, TVEs, etc to seek credit from banks. For instance, when the global crisis struck, China was able to pump in investments valued at $590 billion in a record time and it cushioned the shock within the country and also lifted the global economy. When there is need to curb excessive credit growth, it can be done administratively through banks. At the same time, the system is known to have bred cronyism, corruption, etc. and to overheating. Currently, China is ruing the excess of credit growth and leveraging which is the flip side of its bailout program. See http://www.c3sindia.org/economyandtrade/3695
[xv] http://www.academia.edu/4632107/Public_asset_management_companies_in_East_Asia_-_Case_studies_1
[xvi] http://www.pkusz.edu.cn/uploadfile/2013/1008/20131008052136524.pdf
[xvii] Ibid
[xviii] Which is quoted at $17.6 trillion[xviii] and a conversion rate of RMB 0.16 being equal to 1 USD
[xxii] As it encouraged SOEs to sell equity and retire their debt, some called it the largest debt to equity swap. See http://knowledge.wharton.upenn.edu/article/whats-behind-chinas-stock-market-gamble/?utm_source=kw_newsletter&utm_medium=email&utm_campaign=2015-07-15
[xxiii] Market capitalisation is approximately one-third of its GDP and less than 1% of population participates in the stock market. See ibid.
[xxiv] Ibid
[xxvi] Ibid
[xxviii] Ibid
[xxxiii] A Gini coefficient of zero expresses perfect equality, where all values are the same (i.e. where everyone has an exactly equal income). A Gini coefficient of one (100 on the percentile scale) expresses maximal inequality among values (i.e. where only one person has all the income). A low Gini coefficient indicates a more equal distribution, with 0 corresponding to complete equality, while higher Gini coefficients indicate more unequal distribution, with 1 corresponding to complete inequality Seehttp://en.wikipedia.org/wiki/Gini_coefficient.
[xxxiv] China: External Economic and Financial Relations under the New Leadership by K.Subaramanianhttp://www.c3sindia.org/india/3456 . Also see K.Subramanian ‘China In Transition: Implications for Asia- Economic Dimension’http://www.c3sindia.org/economyandtrade/3948
[xxxvi] Defined as those involving 15 or more people. See Albert Keidel Senior Associate, Carnegie Endowment for International Peace in his paper ‘China’s Social Unrest: The Story Behind the Stories’.
[xxxvii] DS Rajan ‘China: Post- Party Congress Scenario: Policy Indicators in Two Speeches of Xi Jinping’http://www.southasiaanalysis.org/node/1170
[xxxviii] In the Soviet Union, the military was depoliticized, separated from the Party and nationalized and the party was disarmed. A few people tried to save the Soviet Union; they seized Gorbachev, but within days it was turned around again, because they didn’t have the instruments to exert power. Yeltsin gave a speech standing on a tank, but the military made no response, keeping so-called ‘neutrality.’ Finally, Gorbachev announced the disbandment of the CPSU. A big Party was gone just like that. Proportionally, the CPSU had more members than the CCP does, but nobody was man enough to stand up and resist
[xxxix] It presently has no representation in the seven member Politburo Standing Committee while the politburo has two PLA members out of twenty-five.
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