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Tuesday, 01 September 2015 13:21

China’s Faulty Policies – Pumping the Bubbles

Some investors are bullish on China as they view that Chinese government is on a mega reforms path that may have short term negatives but long term positives. The most common reforms cited are – corruption removal drive, rate cut, and devaluation.

As described in previous articles, key Chinese problems are structural weaknesses, imbalanced economy, property bubble, debt spiral, and excess capacity. One has to evaluate the reforms with respect to the problems they are expected to solve.

Devaluation: It will make the Chinese exports more competitive and so manufacturing will also pick up. But can this advantage be sustained over a period of time? Devaluations only make your products cheaper compared to your trading partner countries; it doesn’t reduce their costs in reality. Historically, no country has ever been able to maintain sustainable competitive advantage based on devaluation. Additionally, it makes imports as well as debt costly. China is burdened with one of the world’s highest debt levels compared to its GDP. It is doubtful whether devaluation would help China in long run.

Rate cut and liquidity boosters: Lack of liquidity is not a root problem in China. The only use of a rate cut would be to prop up the real estate prices. Chinese households have huge exposure to real estate which may crumble any time, and this booster dose of government has given it a new lease of life. In absence of good investment opportunities in industries, this liquidity is bound to find its way into stocks and real estate. The property bubble will inflate more; its deflation has been delayed now. Government might have done it as an act of desperation as real estate is about 23% of GDP and a serious price correction will have a major impact on GDP and in turn on employment.

Recently, China scrapped a two decade limit on the percentage of funds banks can lend out relative to deposits. Again an act of desperation, one has to see that it is not the industries which are suffering from lack of liquidity – the government is desperate to prop up its real estate from crashing and to support its deep in debt government organizations from defaulting. In case there are cracks in economy, it will affect employment which is very sensitive matter for Chinese politicians. Right now there is no major issue of unemployment, but it is crucial that enough jobs are created for this world’s largest populated country. It is difficult to believe that by infusing liquidity China will be able to sustain its growth. It is following in the footsteps of Japan which is still reeling under the shadows of low growth for decades now.

Other than pumping the property bubble, easy credit will also increase the already high debt burden of households, government, as well as corporate sector. And deflationary pressures will make it even harder for the debtors. 

Corruption removal drive: Its positive effects would be seen only in the longer run. Right now, it is causing rich Chinese to hide their money abroad or to invest in US property.

Published in Investors Blog

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