July 14, 2017 6:30 pm JST
Joe Zhang

How China has defied the gravity of debt

The state is adding assets to its portfolio, not selling

A string of Chinese private entrepreneurs including China Vanke’s Wang Shi have yielded control of their companies to state-owned enterprises. © AP

Four years ago, I was part of a chorus of analysts who predicted that a wave of privatization would soon sweep through China. Our sense was that the pressure of official debt, already then reaching a scarily high level by global and Chinese historical standards, would force local governments to sell off interests in commercial ventures. Simply too much had been borrowed at interest rates of more than 7% to build roads, bridges, office towers and sports stadiums which were not generating enough cash flow to pay back trust companies and other creditors.

We were all wrong. Although debt levels have almost doubled again since 2013, there is no sign the government is about to unload its vast array of state-owned enterprises. In fact, the state is still building up its portfolio both at home and abroad.

Hardly a day passes without a private entrepreneur succumbing to enticements from the state sector. Among the more striking was the news last month that Wang Shi, founder of China Vanke, the country's largest developer, will step down as chairman and yield control to Shenzhen Metro Group, a city-owned mass transit operator.

What is going on? The economics we have learned cannot tell us just how much debt is too much or how economic theory will work in reality under different sets of political institutions. Over the past four decades, China has aggressively pursued inflationary fiscal and monetary policy, growing its money supply by almost 20% on a compound annual basis. This is despite a painful history of hyperinflation, a key factor in the fall of the government of the Kuomintang, or Nationalist Party, to communist forces in 1949. Today, off an extremely high base, China's money supply is still growing faster than 10% a year.

Despite high inflation over the past four decades, both the government and the public are strangely adamant that a reasonable rate of inflation is not only necessary but also desirable, though no one can define what "reasonable" is. While governments in a number of developed nations are striving to produce even a bit of inflation, China and most developing countries have only sad histories to relate about inflation so more wariness might be expected.

In theory, persistently high inflation should lead to the weakening of the Chinese currency. But over the last two decades, the yuan has been one of the strongest currencies in the world, offsetting much of the depreciation seen in the two decades prior. This suggests enormous erosion in the purchasing power of other major currencies over this time frame and robust Chinese productivity growth.

A crucial question economists have neglected to address is whether China has grown its economy despite high inflation, or at least partly because of it.

Questioning independence

For decades, China's policymakers have talked about the independent central banks of the West with great admiration, although Beijing has never wanted to give any independence to its own central bank. To Chinese policymakers, independence would mean inconvenience.

After the U.S. subprime crisis of 2008, the twists and turns of American monetary policy plus extended congressional debates about official debt ceilings have left Chinese central planners feeling vindicated. Some are now loudly voicing doubts about the very idea of independent monetary policy in the West, never mind independent fiscal policy.

Four years ago when debt servicing started to bother China's regional and local governments, Beijing promptly opened two new fundraising avenues for them. One was public-private partnerships, which effectively shifted state debt to the private sector and to future generations. The other was to allow regional governments to raise new debt in the public market. As a result of these new channels, even the most heavily indebted regional governments have not had to offload commercial assets.

Inflation has made inequality much worse in China, but as long as the economy is still growing at a good pace, any social crisis explosion will be delayed.

All over the world, a popular movement is challenging the accepted wisdom of austerity and fiscal responsibility. For China's policymakers, a united front coming from the West is amusing though somewhat humbling. Western economic governance has long been held up as a role model for China. But in areas such as the independence of monetary and fiscal policy, China suddenly finds the West converging with its own backward model.

Joe Zhang is chairman of payment services company China Smartpay Group and the author of "Party Man, Company Man: Is China's State Capitalism Doomed?" He was previously chief operating officer for state-controlled holding company Shenzhen Investment.

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