Credit Glut Props Up Growth, Sowing Seeds of Trouble Down the Road

China’s GDP grew by 7.9% in the second quarter, buoyed by "extremely loose" monetary policy that has boosted investment growth to uncomfortably high levels. The economic growth promoted by investment alone looks likely to add to both imbalances in internal demand and pressures for economic adjustment in the future.

A glut of cash is producing bubbles in the Chinese economy. The racing credit growth and the low costs for wholesale financing are leading to financing abuses and production surpluses in the real economy. Even lower than usual interest rates have residents transferring their asset preference from bank deposits to the capital market, promoting frothy asset prices.

Increasing real estate prices comprise the main bubble, but without high land prices, local governments cannot come up with the cash needed to fund the economic stimulus package. So, the central government allows the bubbles to inflate.

On July 16, the National Bureau of Statistics released second quarter and first half figures for the year, according to which real GDP in the second quarter grew 7.9%, 1.8 percentage points higher than in the first quarter, and in the first half by 7.1%, year on year.

Many analysts see China’s economy rebounding strongly, but the figures from the real economy do not support this judgment. In the first five months of this year, the profit of industrial enterprises above designated scale totaled only 850.2 billion yuan, down 22.9%, year on year. Of that total, state-owned and state-controlled enterprise profits totaled only 246.7 billion yuan, off 41.5%. During the same period, value-added of nationwide industrial enterprises above designated scale grew only 6.3% year on year, while the growth in the same period last year was 16.3%.

Rapid GDP growth is still being boosted by fixed asset investment promoted by the loose credit policy. In the first half of 2009, fixed asset investment grew 33.5%, year on year, in urban areas by 33.6%. In railway and transportation, road transportation, and water facilities, environment, and public facilities management, fixed asset investment grew 126.5%, 54.7%, and 54.5%, respectively.

Negative growth in the trade surplus has had a negative influence on economic growth. According to earlier statistics, in June it dropped over 60%, year on year, pulling down the growth of trade surplus, which in the first half of the year stood at $96.94 billion, down 1.3%. The trade surplus grew 50.8% in the first quarter of the year, but dropped 40.3% in the second quarter.

In July, total value-added of enterprises above designated enterprise grew 10.7% year on year. This growth is apparently accelerating. However, that of state-owned and state-controlled enterprises and foreign invested enterprises grew only 1.7% and 1.2%, respectively, meaning domestic non-state-owned enterprises were making the main contribution. Although power consumption and tax revenue both saw positive growth in June, the dispute on whether industrial value-added has been overestimated will continue.

CPI has seen negative growth for five straight months and dropped 1.7% in June to a new recent low. PPI has also seen negative growth for seven straight months, and dropped 7.8% in June to a new low.

As the liquidity surplus will not lead immediately to inflation, unseemly CPI growth is unlikely to occur in the second half of this year, and inflation is mainly restricted to assets prices. Housing prices in 70 major cities grew 0.2% year on year in June. If CPI is still controllable, then even if decision makers view assets price bubbles with increasing concern, they may make only slight adjustments to monetary policy.

Loan figures for June released by the central bank show new lending of financial firms reached 1.5304 trillion yuan, and deposits grew by 2.0022 trillion yuan over the previous month.

Bank lending in the first half of 2009 reached 7.37 trillion yuan, while the total credit growth in 2007 was 3.6 trillion yuan, and in 2008 4.9 trillion yuan. As 2007 and 2008 GDP grew 11.4% and 9%, respectively, then with the nearly 7.4 trillion yuan of credit GDP growth in the first half of this year should be over 15%.

Without efficient demand, China’s too rapid credit growth puts great pressure on the fiscal and monetary policies. Lu Lei, an economist, comments, "Why do we need these investments? If the government hopes to increase resident’s disposable income, it can transfer these investments into fiscal subsidy. And if it aims to increase employment, it should adjust the economic structure, especially focusing on increasing the income of hundreds of millions of farmers, instead of reinforcing the existing structure. If the government can’t stand the temporary economic growth decline and allocate financial resources to structure adjustment, China’s road to economic rebound will be tougher and tougher."