China: will the slowdown turn into a rout?

The years of double-digit growth in China "are well and truly over", says Kate Allen on FTAlphaville.com. Year-on-year GDP growth in the second quarter was just 7.5%. With growth expected to ease further over the next few months, China is heading for its weakest year since 1990. But it could get a lot worse than that.

China's transition

There are also only so many bridges and shopping malls you can build before overcapacity renders such projects unprofitable and wasteful. Empty motorways and malls abound, and overcapacity has contributed to producer price deflation, which crimps profitability, further investment and hence growth. Investment comprised an "extraordinarily high" 42% of GDP in 2007, says Martin Wolf in the FT. Thanks to a state-mandated credit boom after 2008, designed to offset the global slump hitting exports, this figure rose to 48% in 2010.

So now the state's priority is to bolster consumption to rebalance the economy away from exports and credit-fuelled investment. But this process is going backwards, says Aaron Back in The Wall Street Journal. Consumption accounted for 45% of GDP growth in the first half of 2013, compared to 52% in the first half of 2012. Household income growth has slowed with the economy, but the key problem is that statepension and health benefits remain "too low to persuade people to reduce rainy-day savings".

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A record credit bubble

China's societal debt load borrowings of businesses, households, and local governments (though not central government) has jumped to 200% of GDP. It has climbed much faster in the past five years than it did in Japan in the five years before its massive bust in 1989, or in the US pre-2008. Overall credit has jumped from $9trn to $23trn since the Lehman crisis. The increase is equivalent to the value of the entire US commercial banking system.

What's more, "gone are the days when the central government exercised tight control over credit through the Chinese banking system", says Jonathan R Laing in Forbes. That's due to the "shadow banking system", which last year accounted for around 45% of China's credit creation. It is a "crazy quilt of institutions and investing instruments", ranging from off-balance-sheet wealth-management products from traditional banks to pawn shops. This opaque world feeds off the banking system and is reminiscent of the dodgy collateralised debt obligations and structured products widely seen in America pre-meltdown.

Meanwhile, there are signs that the economy is buckling under the weight of all this borrowing and simply cannot absorb any more. In 2005-2008 it took one yuan of credit to generate a yuan of GDP growth. Last year it took four yuan of credit to get the same GDP increase. According to Socit Gnrale, China is spending 39% of GDP on servicing its debts, well above the traditional danger level associated with a banking crisis. Estimates of the ultimate economy-wide bad loan tally after this credit binge range to up to 20% of 2012's year-end total debt, says Laing. Given all this, it's clear that "Beijing has a job on its hands", says Lex in the FT, "to ensure this slowdown does not turn into a rout".