After China’s RMB 4 Trillion Stimulus, Now What?

Eight percent: That is the level of 2009 GDP growth that China’s government wanted, and that’s what it got. The government was one of the first in the world to announce a stimulus package to spend itself out of the global financial crisis. And Beijing’s RMB 4 trillion ($585 billion) stimulus arrived with a bold and specific goal: To achieve 8% GDP growth in 2009. With actual GDP growth in 2009 estimated to be between 8.3% and 8.5%, it appears that Beijing has delivered the results. Or has it?

The government does deserve credit for stabilizing the economy. Along with the rest of the world, China suffered a sharp slowdown in the second half of 2008, and many companies in the country experienced a dramatic plunge in business that had not been seen since the country first opened up its economy 30 years ago. Confidence plummeted and companies slashed headcount, including experienced white-collar workers – whereas many of these same companies just a year earlier were complaining about staff shortages and rapidly rising wages.

Within a few months of the stimulus package’s launch, China’s economy began to recover. While GDP growth slowed to 6.1% in the first quarter of 2009, it rebounded in the second quarter to 7.9%. Many companies reported improving sales, while others saw new investment opportunities emerge. Exports continued to lag, but foreign direct investment was strong and domestic consumption rose at a surprising pace.

However, while the government stimulus is maintaining confidence in China’s economy and promoting its recovery, some contend that it conceals serious challenges and exacerbates pre-existing problems.

China watchers are now questioning the medium- and long-term benefits of the stimulus package. Some say it is aimed at the wrong sectors, emphasizing infrastructure projects that have created few jobs and state-owned enterprises that led to industrial overcapacity and starved the private sector of much-needed capital. Others point out that the package does little to generate export growth. There’s also concern that the sharp surge in bank lending that accompanied the program may be inflating asset bubbles, and some of the new loans will be difficult to repay. And in a broader sense, questions abound whether reinforcing the state-led economic model may create more hurdles for China as it moves toward a more market-oriented economy.

Wanted: More Jobs

The belief that China needs to achieve 8% GDP growth to maintain social stability is largely associated with new job creation, and statistics show that for every 1% growth in GDP, one million new jobs are created. Therefore, GDP growth of 8% would create at least eight million new jobs, potentially absorbing much of the 10 million new job seekers entering the market each year.

But 2009 was different. Unlike in the past, the investment-fueled growth last year achieved the 8% GDP growth target but did not create as many new jobs as expected. The reason? Much of the stimulus was injected into infrastructure projects, which require fewer employees than traditional export-oriented businesses, says Xu Mingqi, deputy director of the Institute of World Economy at the Shanghai Academy of Social Science.

“The dramatic decline in exports, on the other hand, squeezed labor-intensive export industries, resulting in millions of migrant workers losing their jobs,” he adds. White-collar employment has also not recovered to previous levels. The official registered employment rate at the end of 2009 was 4.3%, but that does not include unregistered migrant workers or job-seeking university graduates.

As for those university graduates, a recent government-sponsored jobs program highlighted the grim prospects they face. In 2009, for the first time, China’s army targeted universities to recruit about 130,000 college graduates. The government promised to repay their tuition and put them on the fast track to become noncommissioned officers.

Official statistics show that more than 80% of new graduates found jobs in either the private or public sector by the end of October 2009, but the army’s graduate recruitment indicates that the percentage is iikely to be much less. In a survey of 114 graduates who joined the army, 90% of the respondents said that enlisting as petty officers was the only way they could find a job.

Another criticism of the stimulus package is that it favors the state sector over the private sector, perhaps exacerbating an existing problem. The stimulus spending has been heavily tilted toward not only infrastructure, but also state-owned industries. For example, the Ministry of Railway – a legacy of the planned economy as it is both the regulator and operator of most of the country’s railways – received more than RMB 1 trillion ($146 billion) of stimulus money for high-speed rail projects.

The aim of the industrial-restructuring programs, which covered 10 sectors (autos, steel, textiles, shipbuilding, petrochemicals, non-ferrous metals, equipment manufacturing, information technology, light industry and logistics), was to encourage consolidation among companies within each sector and help develop a more streamlined group of enterprises that would be globally competitive. However, in reality, few private-sector companies are benefitting from the initiative given that most of the enterprises being consolidated are state owned.

State-owned companies are favored in a number of ways, including being given more access to bank loans than fund-starved private companies. A flood of liquidity accompanied the stimulus package, as China unleashed about RMB 10 trillion ($1.4 trillion) in new loans in 2009, a record high. Despite this, private companies say they still face high cost of credit, and according to the China Banking Regulatory Commission (CBRC), about 40% of the bank lending following the stimulus went to medium- and long-term projects, most of them related to infrastructure and many of them associated with state-owned firms.

Waste Not, Want Not

Wasteful investment is another problem associated with the stimulus program. A good example is the railway system, the single largest recipient of stimulus spending. For example, two 300 kilometer (km) elevated rail lines are being built almost simultaneously between Shanghai and Nanjing. One is an inter-city express rail linking Shanghai and Nanjing and the other is the high-speed rail link between Beijing and Shanghai, which passes through Nanjing.

Both lines are scheduled for completion before the Shanghai World Expo in May. While the Beijing-Shanghai link is the faster of the two — travelling at an average speed of 350km an hour, cutting the journey between the two cities to five hours from 10 hours currently — the Shanghai-Nanjing railway is only slightly slower at 300km an hour. Why China needs two parallel railway lines on the same route at this stage is a question that remains unanswered.

The financial viability of the new rail lines is also open to debate. Passengers have complained about high ticket prices on the new express railway that links Beijing with the port city of Tianjin 100km away and the 1,000km line between Wuhan in central China and the southern city of Guangzhou — in the latter’s case, rail fares are higher than discount airline tickets between the two cities. Fares on these rail routes are three times higher than on existing express trains, and there’s concern that passenger numbers will be affected by the high prices, making it difficult to cover the construction costs and repay loans.

An associated problem is the high amount of debt financing by local governments. At the national level, deficit spending is at acceptable levels, since the central government’s estimated fiscal deficit is at a manageable 3.8% of GDP. Local government debt, on the other hand, ballooned rapidly in 2009, and the CBRC estimates that local government debt grew to RMB 5 trillion ($730 billion) by the end of 2009 from RMB 1 trillion ($146 billion) in 2008.

The debt is mostly in the form of lending to government-owned municipal development companies, entities that invest in municipal projects like roads, tunnels and subways, using government funds and money borrowed from banks. “The risks of these loans have become much larger,” says Yan Qingmin, head of the CBRC bureau in Shanghai. He reckons that around 28% of the outstanding local government debt — some of which is owed by district or county governments — may be difficult to repay.

The financing burdens faced by local governments, compounded by downturn-induced tax shortfalls, have forced them to rely more heavily on land sales to generate revenue. In total, local governments booked RMB 1.5 trillion ($220 billion) of land sales in 2009, with Shanghai alone earning more than RMB 100 billion ($14.6 billion). In many cities, including Beijing, which pocketed RMB 92.8 billion ($13.6 billion), land sales accounted for more than half of municipal income.

But the land sales also helped fuel the rapid rise of housing prices in 2009 – residential property prices in major cities, such as Beijing and Shanghai, rose more than 30% last year, leading to talk of a bubble. “In a nutshell, the Chinese economy has been kidnapped by the real estate industry,” says Hua Min, director of the Institute of World Economy at Fudan University. “Housing bubbles are doomed to burst, and we are now in the final stages of craziness,” he adds.

Asset bubbles, such as that in real estate, may indicate that the real economy has not recovered to pre-crisis levels. According to the CBRC, real estate industry accounted for 23% of Shanghai’s GDP growth in the first three quarters of 2009, while strategic industries, such as autos, petrochemicals and steel, all of which benefited from the stimulus package, accounted for only the same percentage, at 23.8%.

What to Stimulate Now?

A rise in domestic consumption would help the long-term health of China’s economy, and while consumption is growing robustly, it has yet to make a big impact. Consumption accounts for less than 40% of the economy, much less than in developed countries, like the U.S. (70%), or developing countries, like India (55%).

According to Hua, the growth of China’s consumption closely corresponds to nominal wage growth. On average, nominal wages grew 10% annually in China during the past 10 years, while consumption grew 10% to 15%. With wages flat and unemployment high, it is unrealistic to expect consumption to become the paramount driver of economic growth soon, he says.

Indeed, exports “will remain the lifeline of China’s growth,” he adds. Yet exports in the first three quarters of 2009 declined 20.9% year on year, and if external demand does not recover, he says, “we may end up with a recession combined with asset bubbles.”

Another problem lurking in the background is overcapacity, which Hua believes will emerge again when the momentum of the stimulus slows, especially in infrastructure-related sectors, such as cement and steel. “The overcapacity lies in the gap between investment and consumption,” he says — investment grew 33.3% in the first nine quarters of 2009, compared with consumption’s 15.1%.

Some analysts say the country must eventually wean itself off its dependence on exports and rely more on domestic demand. “The export-led growth model has reached its limit,” says Miles Kahler a professor at the School of International Relations and Pacific Studies at UC San Diego. “The question is whether the stimulus will help change the old model of development in China.”

Xu Xiaonian, a professor at the China-Europe International Business School (CEIBS), agrees that consumption could use a boost. “We need to increase the allocation of assets to the private sector and individual consumers to change the distribution of income and increase the power of consumers,” he says. He’d like to see the government investing more in areas such as education and health care. “The high domestic saving rate in China is the direct result of the low social [spending] rate,” he says. “Many social security functions, especially basic ones, are forced upon individuals, and are not taken care by the government,” which leads to a high saving rate and low consumption. 

What’s clear is that the prosperity built on heavy stimulus spending and abundant liquidity is not sustainable. Both anecdotal evidence and statistics suggest that Beijing’s policy initiatives in 2009 shored up confidence and made China one of the bright spots in an otherwise gloomy recessionary world. However, challenges lie ahead, and painful measures might be required to sustain confidence and economic growth.