‘China overweight but no heart disease yet’

The size of debt is not fatal yet but the speed of growth is worrisome

China is overweight but is not at any imminent risk of heart attack, says Xu Sitao, Chief Economist and Partner of Deloitte China. He also feels that the Chinese stock market needs more reforms and the GDP growth rate has to slow down. Excerpts:

Metal prices rebounded sharply and unexpectedly last year because of Chinese demand. Will it sustain?

China is extremely dominant in many sectors and these need to be consolidated, going forward. For example, if you look at the steel sector which faces severe over-capacities, it is still growing. I don’t think it is sustainable. I think China’s consolidation is very difficult to be understood by outsiders. For example, in a truly market economy, you are not supposed to have significant overcapacity. The government is very cautious and the approach is to consolidate gradually so that companies can have breathing space in order to transform themselves.

The commodity market is generally very volatile. The rebound of prices in the beginning of 2017 suggests that the Chinese economy will hold up. But, this does not mean Chinese economy will go to the old growth rates of 7-8 per cent; a commodity bull market is unlikely simply because consolidation of the steel sector could last a few more years.

What is the impact of environmental issues?

I don’t think China’s pollution is worse than India’s. But, western media tend to be more critical towards China. So, I think pressure is coming from everywhere. China held Olympic Games and in a few years, they will hold the Winter Olympics. As China grows stronger, there will be international organisations permanently in Beijing/Shanghai. You cannot shut down factories when there is an APAC meeting for example but need solutions. But solutions take time. Meanwhile, expectations of citizens who are affluent, are rising fast.

I think the awareness is much stronger compared to a few years ago. Six-seven years ago, people considered pollution as a price you paid for economic growth. Now, pollution is hurting China more so than the developed world. Also, awareness among citizens, especially the middle class, is very high.

For the Government, it is a different story. Because, for officials, their performance is still being measured by economic growth. It is going to take officials a while to come around and understand this. At the same time, economic reform in China really boils down to the critical issue – the role of the government.

How is the stock market in China? What are your views on market regulation?

The stock market has lots of problems. The market is driven by many retail investors who are prone to speculation and rumours. They tend to exhibit herd mentality because the market itself is being affected by manipulations. Chinese regulators are strict and companies must go through an approval process to be listed. But this design has fundamental flaws as the people in this committee might have incentives for rent-seeking as they have the discretion to choose one company over another. Recently, a mid-level regulator was fined $40 million because he gained by helping to list companies.

In the long run, the approval system will be replaced by a registration system. Through this, we allow the market to decide whether the company is good or bad. Since China is in a state of transition with legacy issues, it is difficult to fully embrace this. There is always going to be some sort of approval in place. But, the influence of approval will be reduced significantly through reform.

The other way to improve this market is to bring in foreign institutional investors (FIIs). This will improve the corporate governance and reduce political intervention. After the recent crash, the retail investors question the national intervention — are you here to make money or to stabilise the market? Last week, MSCI decided to add China’s A share market into its index with an initial weight of about 0.8 per cent; this is an encouraging sign.

What is the real picture on debt and what are the solutions?

The size of debt is not fatal yet but the speed of growth is worrisome. In the short term, there is no evidence that the credit boom will be curtailed.

Right now, there is a view in China that the central bank should shrink the balance sheet before the Fed because China has produced more credit than the Fed. So, I would say that there is awareness among policy makers and regulators.

Credit in the country is different from that in India, Canada or Australia. The problem is in the corporate sector, mainly state-owned enterprise. They can tighten up to pay the debt — it is painful. Or sell some assets to raise equity. For this, capital markets should be liberalised so that resources would be allocated more efficiently.

Only when the country is in a crisis and the international creditors are forcing you to pay, there is a problem. But, China won’t be in that situation as it is not a debtor, but a creditor. China is overweight but does not have heart disease yet.

It must lose weight and lower economic growth rate is required for that. In a very simple sense, your economic growth rate cannot be lower than your interest rate payment.

That means, whatever you generate in the future is not enough for you to pay for serving the debt. Also, China has massive room for privatisation.

I really think we need to privatise but that is a far greater political question than an economic issue.

How should one interpret numbers released by China?

You should always take statistics with a pinch of salt. Western cultures tend to be more precise, but it is not the same with the Chinese culture.

In China, there is a sense of fuzziness — ‘more or less’ — rather than a straight number which is very objectively defined. In certain areas, Chinese problems were overstated while strengths underestimated and vice versa.

Profile

Xu Sitao is Chief Economist and Partner of Deloitte China.

He was Chief Representative of China and EIU forecasting director at the Economist Group from 2004 to 2014 and worked for MMS International of Standard and Poor’s Group in Singapore, Standard Chartered Bank, Societe Generale and Industrial & Commercial Bank in Hong Kong.

He holds a B.A. in Economics from Peking University, M.A. in Economics from the University of Connecticut, and M.S. in Finance from Boston College

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