Interaction with Dr. Anantha Nageswaran

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"The Chinese Economy: Trump Effect, Deleveraging, or Both?"

The Vivekananda International Foundation organized an interaction with Dr Anantha Nageswaran (non-permanent Member of PM Economic Advisory Council and Distinguished Fellow, VIF) on 5th December 2019. Dr Nageswaran’s presentation focused on addressing the thematic question of slowdown in "The Chinese Economy: Trump Effect, Deleveraging, or Both?” The presentation was a follow up in the ongoing series of talks given by Dr Nageswaran at the VIF. The discussion was moderated by Amb. Prabhat P Shukla, Member of VIF Advisory Council. Some of the salient points raised in the presentation and the consequent discussion were:

• Chinese Political System suppresses risk factors, but not unsustainability of growth

Concerted political, economic and financial repression by governments make it possible for risk factors to remain suppressed for a long time before they erupt into a full-blown crisis. The autocratic nature of the Chinese government has allowed leveraging to be better disbursed and utilized than the private banking sector of Europe or Japan. But even though worries arise over ‘economic contagion’ fueled by China’s debt binge, it is curious why it has not resulted in ‘market contagion’, where markets seem to be okay with China’s increasing appetite for larger leveraging and credit stimulus packages. Yet all these do not mitigate the underlying unsustainability of the Chinese growth model.

Chinese Growth Figures deny Economic Rationale

China crossed its Lewis point around 2010. Further unfavorable demographics, very high investment ratios, expansive shadow banking, negative business sentiment, an undervalued exchange rate and high levels of corporate and household debts raise doubts on the exceptionalism of the Chinese story and make its growth rates somewhat difficult to take at face value. In fact, in 2007 Premier Li Keqiang (when he was the Communist Party head of Liaoning), at a dinner with then US Ambassador to China, Clark Randt, had said that he did not trust the provinces’ GDP numbers and looked at railway cargo, electricity generation and bank loans to get an idea of the economic activity. Thus, there are valid questions on the economic rationale and authenticity of the official growth figures of China.

2016 Credit Binge

In 2016, China initiated another credit binge in the midst of stock market turbulence, massive capital outflows (amounting to nearly one trillion dollars) and a rapidly slowing economy. China's central bank cut benchmark interest rates almost five times and lowered banks' reserve requirement ratio three times. The Ministry of Finance also accelerated public spending and rolled out a 3.2 trillion yuan ($494 billion) debt swap for in-the-red local governments. So what seemed like a moment of reckoning, China was able to tide over with the international support in the G20 Hangzhou Summit. However, even with the changing US geostrategic narrative, questions still arise on the ‘Too Big to Fail” rationale associated with China. Also, though the 2016 credit binge seems to be tapering off, it is anticipated that China will hold off indulging in another credit stimulus until 2021-2022, dates which will be politically important for the CCP.

IMF Prescription and Current Account Surplus in 2019

The geopolitical and geoeconomic contradiction of the west on China is most evident in the IMF policy prescription that aims at returning China to a current account surplus that will allow for larger leeway to maintain negative interest rates. The IMF has been advocating—over time—to China a 7.5 percentage point (pp) of GDP fiscal consolidation together with a slowdown in the growth of private leverage. A 7.5 pp fiscal consolidation is normally expected to generate roughly a 2.5 pp of GDP swing in the external imbalance. After the expansion of the current account surplus in the first half of 2019, China’s surplus is now between 1.5 and 2 pp of GDP. The Fund’s fiscal recommendation—if fully implemented—would generate a current account surplus of over 4 percent of GDP. That’s quite large in dollar terms—$800 billion or more, given the projected future size of China’s economy.

Role of Chinese Foreign Exchange Reserves is overstated

China’s foreign exchange reserves peaked at nearly $4 trillion in mid-2014 before they started to decline. The reserves shrank dramatically by about $1 trillion in about a year, after China’s stock market rout in the summer of 2015 triggered a capital exodus. While Chinese forex reserves are seen as a major cushioning factor for China’s credit binge, it is speculated that the value of around $3 trillion is held steady by a revaluation of the assets. China’s external debt has been steadily rising and stands at around $2 trillion (2019 figures). Further, there is another $680 billion of debt held by Chinese overseas subsidiaries making the repayment schedule of Q2 2020 to Q2 2021 a crunch time for China.

Is the CCP hindering Chinese Growth?

The factors leading to the fall of the Berlin Wall thirty years ago, have been studied intensively by China’s Communist Party leaders, lest a similar calamity befall them. Fear of what liberalization might bring underlines Xi Jinping’s Leninism, which is the Party must remain dominant everywhere. Thus, even though high growth rates did not bring democracy to China, the flip side of the argument that a slowdown in growth will bear repercussions for the CCP holds equally true. In fact, the inability of the Party to relax control is seen by many as to why China’s economy has done worse over recent years than expected. Some analysts argue the Party will have to liberalize the economy eventually, if income growth slows too far. But the shift from bottom-up organic growth to top-bottom controlled growth post-Tiananmen, shows the Party will not let go of its control purposefully.

RCEP

The Regional Comprehensive Economic Partnership has been all about tariffs, even though tariffs between most RCEP members are already low. Since it does not seek to raise trading standards, its economic impact will remain overall small, even if India were to remain inside. But as a regional deal, it has been a win for China since it gets to play role of defender/promoter of global trade without committing to any rollback of its industrial policy etc.

The Trump Factor: Countering China in the Long Term

On the question of the role of Trump factor in Chinese economic slowdown, it was argued that the explanation for the current slowdown goes beyond tariffs imposed by the US on Chinese goods. Yet, the cut-throat policies on technology through examples of 5G and Huawei indicate that the US is very much looking to counter China in the long term. Further, the American anti-China rhetoric has also led to definite geostrategic pushbacks against China. Countries are now more willing to speak up on Chinese unilateral aggression, security threats posed by Chinese M&A(s) and protectionist economic policies for the mainland market.

Aging

It is undeniable that aging remains one of the most understated challenges to the Chinese economy. With an imminent slowdown and lack of a viable social welfare system, aging demography amid gender imbalance, indicates China is likely to become gray before it becomes a rich economy.

Currency of International Power is Military Power

One of the biggest questions in geopolitics today is, at what moment an economic slowdown will impinge on China strategic aspirations. Drawing from the erstwhile USSR example, though it took Russia almost a decade and half to reach soviet economic levels, its military power remained strong all along the way to make it a geopolitical contender. The currency of international power still remains military power. So, even though economic slowdown will bear repercussions for Chinese polity, India will have to deal with a militarily strong China for the time ahead.