In a country like China which has such a low household consumption rate, who is supposed to buy the goods and services to be produced with the huge capacity developed via rapidly growing investments?

While everyone is fixated on Europe, some experts are persistently warning that things are not going on track in China lately. I read four commentaries in this direction in the last three weeks. The one I will refer to today was highlighted on Bloomberg website on December 19. The author stresses that the actual credit risks of Chinese banks are higher than declared. One of the main sources of the risks goes as follows: local governments initiated large construction investments in order to minimize the impact of the global crisis. Though those investments are financed someway, the risk is after all borne by the banking sector.

Roubini warns as well
A second warning came from Nouriel Roubini. He argues, if the downturn in housing and land prices in China continues, local governments will be unable to pay a large proportion of their debt. He stresses that this would pose a critical risk for banks. According to his base scenario, this problem will not transform itself into a banking crisis in the next couple of years. But Chinese growth will slow down gradually, he expects. He estimates that growth rate will decrease from 10.4 percent in 2010 to 7 percent in 2012-13 and to 5.4 percent in 2014.

The third warning came from Yılmaz Akyüz, my dear professor and former chief economist at United Nations Conference on Trade and Development. For the latest issue of the İktisat ve Toplum journal, he wrote an important article titled, “The Global Crisis and Growth and Stability in Emerging Economies: A Double Lane Road or the End of the Road? – Küresel Kriz ve Yükselen Ekonomilerde Büyüme ve İstikrar: Çift Şeritli Yol mu, Yoksa Yolun Sonu mu?” The fourth warning sign came from Nobel Prize Winner Paul Krugman at New York Times on December 18.

The last two articles point at one key challenge which increasingly deepens and turns to be unsustainable: Chinese economy has been growing rapidly. Albeit, the ratio of consumer spending to gross domestic product is around 35 percent, way below the rate that would be observed in a “normal” economy. Cited from Yılmaz Akyüz, until 2008, private consumption in China grew at a rate below 8 percent whereas national income grew by 10.5 percent. The demand gap was closed via exports that annually grew by 25 percent on average and correspondingly investment spending that grew by 13 percent on average.

Who will buy the goods?
In a nutshell, China has been trying to grow rapidly by closing the gap between national income growth and consumption growth with exports and investments. Until today, it succeeded. The problem is that, given the current environment marked with sluggish recovery in the US and the chaos in Europe, it will be difficult for China to maintain the export performance of good times. Moreover, even if Europe turns around, the rate of growth in household consumption expenditures will hardly be as high as that was experienced during the period when the housing bubble was formed. Therefore, Krugman stresses, China’s exports will not grow as rapidly as it used to do.

In a country like China which has such a low household consumption rate, who is supposed to buy the goods and services produced with the huge capacity developed via rapidly growing investments? In addition, as I stressed at the beginning, local governments have been carrying out massive construction projects financed with low-cost and abundant bank loans. In short, a huge bubble is formed in China and fears grow that it will burst. Of course, a chaos emerging in China is just a possibility for now; what is feared of might prove wrong. And even if it does materialize, the timing cannot be foreseen particularly given that the US will not reverse the liquidity injections and the Federal Reserve will not intervene to push interest rates up in 2012. But it is still useful to regard the warnings.

This commentary was published in Radikal daily on 22.12.2011