Gene Frieda writes: \u00a0China\u2019s economy is increasingly two-tracked: a new track based on services and consumption burdened by an old, slower track made up of industries like steel and mining, which are inefficient and suffer from excess capacity. Straddling both tracks is the country\u2019s real-estate market, which is characterized by massive overcapacity in mid-size and smaller cities and robust demand in large cities.<\/p>\n
The problem is compounded by the Chinese leadership\u2019s insistence on sticking with high growth targets \u2013 7% at present \u2013 and the resulting reliance on credit to produce the requisite output.<\/p>\n
The meteoric rise and subsequent crash in the country\u2019s stock market has left investors badly rattled. But the real wake-up call has been the belated effort to sort out local government borrowing and misspending.<\/p>\n
In November 2013, President Xi Jinping laid out a reform agenda that sought to increase the role of the market in China\u2019s economy.<\/p>\n
In early 2015, the central government announced plans to convert the local governments\u2019 short-term, high-interest bank loans into long-term bonds. By increasing the maturity of the debt, the central government hoped to alleviate financing constraints on local governments and allow them to pursue financial stimulus.<\/p>\n
When China\u2019s banks balked at accepting the low yields offered on the new bonds, the goal of increasing the market\u2019s role in the economy went out the window. The government forced banks to execute the debt swap. Unsurprisingly, banks suddenly became risk-averse. Local governments discovered that even with an improved liquidity position, banks were reluctant to extend new loans.<\/p>\n
Meanwhile a slump in the real-estate market deprived local governments of their main revenue source: land sales.<\/p>\n
China appears to be falling into a trap that it assiduously sought to avoid. The country\u2019s debt problem looks set to worsen as the government neglects its reforms in favor of short-term growth objectives.<\/p>\n
The government has sought to increase liquidity by dropping controls on the movement of capital. Doing so not only further undermines its control of the economy; it also creates the risk of a full-blown financial crisis that could engulf its neighbors and other emerging markets.<\/p>\n
China\u2019s property market is deflating. Its equity markets have been discredited. And its economy seems increasingly sluggish. As a result, the country\u2019s vast pool of domestic savings is increasingly looking to move abroad. Relative to the size of China\u2019s foreign debt and the sheer volume of money that could go abroad, even its $3.7 trillion in foreign reserves starts to look puny.<\/p>\n
Like termites, debt has a unique capacity to make short work of an economy\u2019s foundations. By the time the infestation is recognized, it is often too late. If China is to reverse the damage, it will need to focus on debt deleveraging, repair its capital allocation mechanism, and delay the abolition of capital controls.<\/p>\n
Gene Frieda writes: \u00a0China\u2019s economy is increasingly two-tracked: a new track based on services and consumption burdened by an old, slower track made up of industries like steel and mining, which are inefficient and suffer from excess capacity. Straddling both … Continue reading ![\"China's](\"http:\/\/www.w-t-w.org\/en\/wp-content\/uploads\/2015\/08\/silhouettes_cartoon_termites_eats_wood_things_cg8p9888006c-287x300.jpg\")
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