China lending Dec14Can you imagine your government publishing a report that showed $6.8tn has been wasted in “ineffective investment” in the past 4 years?  That is $6.8tn, by the way, not a typo.   And it is more than Japan’s total annual GDP, or the combined annual GDP of Germany and France.

No, I thought not.  I certainly cannot remember any government in recent times admitting to such a mistake.  But then, as I noted earlier this year, very few Presidents do as President Xi did a year ago, and open a key economic policy session by announcing:

The good meat is all gone; all that is left are hard bones to chew”.

The $6.8tn number comes from a new Report by the high-powered National Development and Reform Commission (the state planning agency), and one of its Academies.  They estimate that worthless investment totalled Rmb7.9tn in 2009; Rmb 5.4tn in 2010; Rmb 4.7tn in 2011; Rmb 10.6tn in 2012; and Rmb 13.2tn last year.

Encouragingly, the detail of the Report seems to mirror the analysis in my February Research Report, China Bank Lending: from $1tn to $10tn and Back Again?, to judge by the summary in the Financial Times:

The bulk of wasted investment went directly into industries such as steel and automobile production that received the most support from the government following the 2008 global crisis, according to the report…..Ultra-loose monetary policy, little or no oversight over government investment plans and distorted incentive structures for officials were largely to blame for the waste.”

The interesting question, of course, is why the government has taken this step?  Almost certainly, its key objective must have been to highlight its determination to change economic direction:

  • Publication makes it certain there is NOT going to be a major new stimulus programme
  • This has now become impossible with the results of the previous programme now exposed
  • Instead it prepares the ground for further major cutbacks in lending
  • As a result, economic growth is likely to be much lower than the consensus currently expects

The charts above tell the story.  On the left is data for official lending data, which shows just a 6% increase versus 2013.  On the right is data for shadow lending, the real target at this stage.  It shows a 30% decline versus last year, most of it in the last few months.

CHINA’S GDP GROWTH IS TEMPORARILY HEADED FOR ZERO
As I warned back in May, China’s transition towards a more sustainable economy will inevitably be painful:

  • Its one thing to announce that you intend to move from a wasteful investment and credit-led model towards one that relies more on consumption and services.  Everybody cheers that
  • But it is quite another to cut off funds for pet projects being promoted by Party officials.  Or to take the risk of a major downturn in the real estate market – no matter how necessary and overdue this has become

This is surely the true significance of the new NDRC Report.  It echoes Premier Li’s statement in his first press conference last year.  He warned then that the planned changes would “feel like cutting one’s own wrist“ – a reference to the Chinese legend in which a warrior who had been bitten by a snake cuts off his hand to save the rest of his body.

What does this mean for growth?  I would argue it confirms my forecast last February:

The seriousness of the situation, and the dire warnings being given by the leadership about the necessity for change, suggest that the current debate over China’s likely level of GDP growth is missing the point.  Zero growth at some point in the next 2 – 3 years would seem to be a prudent Base Case.”