China Research

When I visited China in early May this year, I really got the impression that China was strongly interested in a European recovery as soon as possible. China cares about the EU and EMU – probably mostly for its own sake (which is a normal emphasis and reaction). This includes that China really wants to have a strong economic counterpart to the U.S. in the Western hemisphere – and that it has been investing a lot of money in the Euro since its start.

China’s worries about the economic development of the EU/EMU have been confirmed in recent months statistically, too. Chinese exports have slowed down visibly – particularly what concerns exports to Europe. And the problems that are linked to the crises in mainly Southern Europe have not declined either since spring.

Chinese GDP is now growing slightly below expectations (q2: 7.6 %). This causes concerns since the current president Hu Jintao and prime minister Wen Jiabao certainly do not want to leave the economy to the next generation of political leaders in a worrisome shape. The situation in Europe contributes substantially to the worries.

It is not very common that the Chinese give policy advice to leaders of other countries when they visit China. For this reason, it was quite illuminating that prime minister Wen Jiabao recently explained to the German chancellor Merkel that countries in certain situations cannot solely concentrate on structural fiscal recovery – but also have to rely on traditional Keynesian policy if economic growth is fading too much.

Wen mentioned that China has been very successful in this respect. To some extent, he may be right (at least without regarding the risk of overinvestment). But what China neglects is the point that China has not deregulated cross-border financial flows like the affected EMU countries have – and, consequently, cannot be hit sharply by global speculation. Furthermore, China had – and still has – the advantage of a positive current account balance. This means there is no real need of net borrowing abroad. In other words: Conditions for Chinese expansionary fiscal policy are very different from conditions in Southern Europe (apart from the non-transparent issue of the real size of the Chinese government debt).

Another reason why China is very unhappy about the European debt crisis is of a more financial nature, i.e. the capital losses that derive from the weakening Euro. China wants to diversify its currency reserves from the U.S. dollar to a higher of the Euro. Currently, however, such a strategy is counteracted by the weakening Euro. Despite the ongoing challenges, however, China still invests in the Euro (example: according to the statistics of the EFSF, around 14 % of its funding comes from Asia, Japan excluded, which should be about Euro 5-6 billion of Chinese origin – which on the other hand is not an amount that is really supportive to the Euro).

Altogether: China cares a lot about Europe, the EU and the Euro. But there is not very much China can do or will do to dampen the European crisis more significantly.

Hubert Fromlet
Professor of International Economics
Editorial board

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This is astonishing since the Chinese economy has by now climbed to the second position in global GDP ranking (total, in PPP terms). Thus, the development of China’s government debt matters increasingly to Europe as well, both in a macroeconomic and an applied corporate perspective.

Furthermore, not enough is known about the real size of the total Chinese government debt. Insufficient statistical transparency is an important reason for this shortcoming, but this should not serve as an excuse. Increasing efforts are needed to provide China and the rest of the world with better information on the real state of Chinese government debt. This need is underlined by a special survey with Linnaeus University’s China Panel in March/April 2012.

In this paper, an attempt is made to explain and discuss/roughly estimate the real situation when it comes to the Chinese government debt. The current Greek debt misery clearly shows that opaque statistics, even in small countries, cannot be hidden away forever without sooner or later puzzling and/or frightening the financial markets. On the other hand, China cannot be analyzed completely with Western eyes.

The sooner decision-makers decide on greater transparency in the total government debt situation, and decisive steps towards more efficient fiscal policy are taken, the better the consequences for China itself and for the European /global economy. The alternative – continuous opaqueness and a possible future fiscal turmoil or explosion -could certainly do a lot of harm to the European and global economy. There is no reason to underestimate this medium and long-term risk coming from government debt. The short-term perspective looks safer.

There should be room for a greater exchange of views and co-operation between EU and China, too. The EU’s own bad experience from the past few years could be arealistic starting point.

JEL Classifications: D 02, D 82, H 70, H 74, O 53, P 35

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Hubert Fromlet
Professor of International Economics
Editorial board

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The Chinese growth model has depended on high level of investments. In this China is very similar to many other fast-growing Asian countries, including Japan and Korea. During the 1980s and 1990s share of investments in GDP fluctuated between 30% and 40%, but the last decade or so has seen an upward trend in the share. Furthermore, during the 2009 economic crisis the Chinese government used e.g. infrastructure investments as a fiscal stimulant, and the investment ratio jumped close to 50% (see Figure 1).

Figure 1 Investment ratios

Extensive investment activity has been financed from two main sources. From companies’ retained earnings (as in most other countries) and from bank loans. According to the Chinese flow-of-fund data, non-financial enterprises borrowed from Chinese banks amount equaling some 23% of GDP in 2009. The Chinese banking sector was very large (relative to China’s income level) already before the crisis, but Chinese banks’ balance sheets expanded sharply in 2009 and 2010, as the government used banks as an instrument of economic policy, i.e. in financing the vastly increased infrastructure spending by the local authorities.

Figure 2 shows the positive correlation between the size of the banking sector (domestic credit as percentage of GDP) and a country’s income level (per capita GDP adjusted for purchasing power parity). Many high-income OECD countries have very large banking sectors, as we can see. Also, most banking sectors do not exceed 100% of GDP, even at relatively high income levels. Therefore, in international comparison, China (denoted by red markers) stands out as an outlier. China is also very different from the formerly socialist countries in the Central and Eastern Europe, where domestic credit remains even below 50% of GDP. One can also note the very large jump upward in the size of the Chinese banking sector from 2008 (104% of GDP) to 2009 (127%). Currently the Chinese domestic credit is on the level more commonly seen in countries where per capita GDP is well over $20,000.

Figure 2 Domestic credit to private sector and per capita GDP 2005-2010

China’s banking sector is already very large relative to its size. This is a result of both the chosen growth strategy and the relatively stringent controls on the financial sector still in place. E.g. Chinese banks’ interest rate margin is almost directly controlled by the authorities. When the financial market liberalization progresses further, competition in the market will increase. Also, Chinese households and companies will have greater access to other forms of investment than bank deposits. All this will mean smaller relative size of the Chinese banking sector.

Iikka Korhonen
Head of Bofit (Institute for Economies in Transition) at the Bank of Finland

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