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House of Cards

China's 'unsustainable'' economy weighed down by debt

Hopes that the continuation of China’s long boom will drag the rest of the developed capitalist world – the so-called advanced economies – back from contraction have been further dashed.

The country’s part in the global economic spiralling slowdown was underlined yesterday when rating agency Moody’s joined Fitch in downgrading the country’s credit outlook. The downgrade from positive to stable was the agency’s response to the news that China’s growth rate has slowed to 7.7%, continuing the downward trend of the last two years.

News of the slowdown – greater than expected by market speculators who were banking on 8% or higher – reverberated around the world. Prices on the commodity and stock exchanges dropped sharply as demand for key inputs, including copper and oil, will fall.

Fitch downgraded its China rating last week. The agency sees warning signs in the massive expansion of credit from 130% of gross domestic product in 2008 to 200% in 2012. This is partly the result of the state’s huge investment in new cities and transport infrastructure, which was the response to the 2007-8 financial crash.

But the growth in credit is also the product of a hardly-regulated shadow banking industry offering “wealth-management” products to the minority of new rich who’ve benefited from China’s emergence as the world’s second largest economy.

The investment from abroad in search of cheap labour, which drew millions of Chinese into the workforce serving the profits of global corporations is now in decline as companies like Foxconn, which runs Apple’s assembly plants is looking elsewhere in the world. Some corporations are even returning to the United States where real incomes have been driven down.

China’s state infrastructure programme, heavily promoted by former premier Wen Jia Bao, encouraged local administrations into spending way beyond their means in order to stave off the worst effects of the global crash, but he saw its limits.

"Another year of propped-up growth via state spending and a credit deluge would, we fear, push China dangerously close to proving Wen Jiabao correct – that the current economic model is 'unsustainable'," said Alistair Thornton, senior China economist at IHS Global Insight. "If something is unsustainable, at some point, it won't be sustained."

Despite the warning signs, China’s central bank has cut interest rates twice since June to reduce borrowing costs for businesses and consumers and increase lending.

And China is far from exempt from the continuing global slowdown. Yesterday the International Monetary Fund once again cut its forecast for world growth to 3.3% for 2013, from its January prediction of 3.5% whilst trying but failing to convince the markets that it remains upbeat about the future.

The IMF’s latest World Economic Outlook sees the eurozone as a whole contracting by 0.3%, the US slowing to 1.9% growth as the government slashes spending, but it also saw growth slowing in large emerging economies like Russia, China, Brazil and India.  

Summarising the latest set of global data, leading economics professor Eswar Prasad says: “The global economic recovery remains stuck below takeoff speed, unable to achieve liftoff and facing the risk of stalling.”          

Prasad’s warning that “politicians around the world continue to avoid tough structural reforms, instead relying on central banks to continue propping up growth”, implies a redoubling of the assault on living standards that has produced 60% unemployment among young people in Greece and Spain. 

Without these more vicious “reforms”, says Prasad, “policy and political uncertainty remain sources of drag that could prevent the world economy from attaining liftoff, raising the risk of a crash”.

On the day that UK unemployment rose by 70,000, you have to say that the “crash” Prasad warns about is a more likely outcome than “liftoff”.

Gerry Gold
Economics editor
17 April 2013

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