When the Chinese authorities banned for-profit tutoring in July, this might have sounded a bit strange to Western audiences. However, the measure was not only an attempt to alleviate the skyrocketing educational costs for families under the “common prosperity” initiative. What many did not understand is that it was also an effort to boost the purchasing power of the middle classes so that they could buy more Chinese manufactured goods and reduce the economy’s dependence on exports.
China has many surprises in store in 2021. Specifically, its growth has slowed more than expected. As a consequence of political reforms, credit restrictions and electricity cuts, we believe that GDP growth will close the year at 7.5% -8% and that it will continue to fall to below 5% in the first mid 2022.
However, the political reforms are just as surprising.
Beijing has taken advantage of the high growth rate in early 2021 to put its affairs in order, which is commendable. Looking ahead, you need to achieve a delicate economic balance: keep the unemployment rate below the critical level of 5.5%, and at the same time continue to impose credit restrictions on highly leveraged sectors such as real estate, government local and state companies. In parallel, the Chinese authorities are striving to stimulate domestic consumption and reduce dependence on the outside world – both in terms of exports and foreign investment – in a period marked by persistent trade tensions with the United States.
As it pursues these strategic goals — namely, financial stability, social stability, and self-sustaining growth — China will define its financial stimuli more precisely than before. Although credit will remain unchanged in real terms in 2021 (an expansion, in our opinion, close to 11%), the most important aspect will be the reallocation to priority sectors: the manufacturing sector with high added value, green energy and small and medium businesses. Since joining the World Labor Organization 20 years ago in 2001, China has been the world’s low-cost production center. However, given the deterioration of foreign relations, the Asian giant is choosing to protect supply chains and strengthen its economy. In the next ten years, China will start producing for its own population.
How will you persuade the middle classes to buy Chinese goods? It should be remembered that The average Chinese person saves a lifetime for three things: a house, their children’s education, and health care. Thus, reducing the costs of education and housing plays an essential role in reorienting China towards the domestic economy.
The asset quality problem facing the financial system
The stabilization of the real estate sector has an impact on the quality of the banking sector’s assets. Although the difficulties faced by Evergrande, one of the largest developers in the country, in servicing its debt are well known, the problems facing the real estate sector are actually much greater. Property developers’ debt, which amounts to RMB 20 trillion (USD 3 trillion), represents around 10% of total corporate credit or around 20% of nominal GDP.
China’s small and medium-sized banks, which largely financed the 2020 credit expansion to combat the effects of the pandemic, have the greatest exposure to real estate. While the big five banks are well capitalized and have grown in an orderly fashion, about half of the smaller banks are technically insolvent (if we use Western scales). Since the global financial crisis, the assets of the top five Chinese banks have increased from 110% of GDP to 135%; in contrast, the assets of smaller banks have soared from 90% to 190%.
Yet China is aware of the problem and has the resources to solve it. A financial crisis seems unlikely, since there is no clear channel of contagion to the world financial markets. Indeed, Chinese banks are financed domestically and the People’s Bank of China can draw on a powerful arsenal of tools to deal with a financing problem. There are potential internal and external catalysts that could lead to a funding freeze, although neither of these would materialize without a loss of confidence in the system, which is unlikely.
1 Bloomberg, “China Considers Turning Tutoring Companies Into Non-Profits,” July 23, 2021
2 Reuters, “China Evergrande shares fall on persistent pressure from debt travails,” October 27, 2021
3 Autonomous, October 2021
4 PBOC, Autonomous, Emerging Advisors, IMF, ECB, Federal Reserve, 2021