What's Wrong With China Economy?

China economy had grown fast in the last decade, but it has been affected by unhealthy rumours since last year. In fact, it was also appointed as the catalyst behind the turbulence in global stock market. What actually happens with China economy?

China economy had grown fast in the last decade, but it has been affected by unhealthy rumours since last year. In fact, it was also accused as the catalyst behind the recent turbulence in global stock market. What actually happens with China economy?

Debt Financed Growth

In 2014, rumour had it that China economy was threatened by credit crunch possibility, prompted by fiscal debts that swelled up after local governments went all out with their borrowings to stimulate growth in each of their areas. Corporate debts also became the highlight after several large companies were in default. Local government and private sector's hobby to finance development with loans had become the major threat for economy growth.



Yet, the government managed to overcome the problems by rescheduling payment, swaps, and many other policies. At this point, people probably had forgotten that China was shadowed by credit crunch not long ago. But had the problems really been solved?

According to Bloomberg survey in the middle of July, corporate and household debts had spiked to 207% of GDP in the end of June 2015, almost twice the size of the number in 2008 where it reached 128%. Those records didn't even count gorvernment debts. Furthermore, the number can continue to grow as People's Bank of China (PBOC) repeatedly cut interest rates and add stimulus.

Economics basic theory says: people would be interested to take on more loans if rates are low and there is a lot of money in circulation. On the other side, higher loans can increase credit crunch risk and weaken people's confidence in China's capability to pay them back. No wonder people recently became skeptical of China government attempts in connection with stock market's ordeal.

Unsustainable Development

Aside of impending credit crunch, China economy growth is also loomed by another issue, namely unsustainable development. The shooting growth of China economy has been standing on worryingly fragile foundations such as: wasteful infrastructure developments, messy management of human resources, and environmental damages.

China local governments has been known to optimize unnecessary infrastructure developments like railway project from Lanzhou to Xinjiang, which stretched up to 1,800 km and crossed desert in one of China's most uninhabited parts. You can try to google China wasteful infrastructure and you will find dozens of other unnecessary projects. It's difficult to put the blame entirely on China, since the developments were probably launched to provide more jobs for the country's world's largest population.

Meanwhile, China's labor force now has to face an eerie prospect since the country's one family one child policy is becoming a boomerang. The next generation will be filled with more elderly people but less younger and productive citizens. Imagine if two older generations (grandparents and parents) are to be supported by only one younger generation in a family. It will be a great burden not only for that one person, but also for the whole economy.

View of Tiananmen Square, Beijing, in January when the city's air was heavily polluted.

The condition is worsened by environmental damages in big cities that has reached life-threatening level. One example can be taken from air pollution in Beijing and the surrounding areas, which is so severe that it becomes dark colored and dangerous for human's health. A documentary film made by a Chinese environmentalist that is called Under the Dome exclusively spotlighted this concerning issue. Air pollution is the result of factories and industries' ignorance toward environmental standards. They prefer to choose easier ways in favor of pressing the production costs as low as possible. In the long term, this kind of behavior will endanger the human life, increase health costs, and threaten economy growth.

Stock Market Bubble

It was revealed that the culprit behind China stock market fall-off was the excessive margin loans given by Chinese brokers to retail investors. The so-called margin loans used to be important for boosting China stocks values, but they also created a domino effect; one push and stocks began to fall down one after the other.

As discussed by most analysts: When the stock market is under pressure, investors will encounter margin call from their opened trades. There is no other choice but to exit the market and sell their shares. In turn, it will trigger massive sell-offs and increase volatility, especially in Shanghai Composite Index.

Shanghai Composite Index before and after the crash in the beginning of July 2015 (Business Insider)

China government shared a part of the blame in causing that condition. In an attempt to prevent the financial system collapse, the government propped up bailouts here and there. It was like bailout became the only solution for each problem. Troubles from local governments' debts and stock markets were all answered by bailouts. The question is, how long will the government be able to bail such frail systems? No matter how rich the country is, there are limits in the matter of market intervention, more so in keeping the obviously bubble condition. Market mechanism will always correct itself to adjust with the fundamental basis, and government involvement is only going to corrupt its balance.

Yuan's Dilemma

Yuan's status as managed floating currency presents another complication in this story. In one hand, China always manages to keep its exchange rates within certain levels as an effort to maintain product prices in the international market. In the other hand, China is now intending to globalize its currency; for it to be used for international trading purposes and becomes one of the central banks' currency reserves in IMF. As the result, the government always tries hard to control and stabilize their currency rate.

Optimizing the two efforts is clearly not easy or even cheap. The central bank needs to sell Dollar and buy Yuan frequently to keep currency rate steady within the intended levels. In consequence, it indirectly sucks in the domestic liquidity, which contradict the central banks's intention to cut interest rate and add stimulus. This circumstance ultimately leads to people losing trust towards the government. The more China government give stimulus, the more investors lose their trust in Yuan. Instead of acting as the solution, this kind of effort only messes up the condition even further.

Many sides have claimed that Yuan will be the second most dominant currency in the world, competing with the US Dollar. However, it can't possibly happen anywhere in the near future if we consider the disproportion in current economy condition. China needs to solve its domestic problems first before enabling their currency to be used by other countries. That attempt is required to stabilize the currency rate for real, not by routine interventions.

China growth is forecasted to fail in reaching 7% this year. The level is far lower than average growth in the 2000s at 9.5%. Yet, it is probably a necessary phase for China to balance the flawed economy segments. Approximately up to the next decade, the world is going to bear the consequences which appear in the forms of weak demands and low commodity prices. Only after the solution is achieved then economic cycle can progress to the next stage.