China Seen Robbing Consumers With Low Interest Rates
Peking University professor Michael Pettis was discussing declining bank-deposit returns when a student interrupted with a story about her aunt that may stymie China’s plan to boost consumer spending.
“To send her son to university in six years it means she must replace each yuan in lost income with one from her wages,” the student said, according to Pettis.
The government’s policy of keeping interest rates low to reduce the burden of soaring municipal debt is costing savers as much as 1.6 trillion yuan ($236 billion) a year in lost income on bank deposits, according to Pettis, former head of emerging markets at Bear Stearns Cos. To make up the shortfall, savers have to set aside a larger proportion of wages, undermining China’s efforts to counter slower export growth with consumer spending at home.
“Consumption is already at a dangerously low level,” said Pettis, author of the “The Volatility Machine,” a 2001 book that examines financial crises in emerging markets. “If it doesn’t begin to rise very quickly, China has a problem because household consumption will continue to drop as a share of GDP.”
Emphasis on exports and investments have caused domestic consumption to fall to 35 percent of gross domestic product, the lowest of any major economy, from 45 percent a decade ago, Societe Generale AG says.
Pettis isn’t alone in being skeptical about a consumer boom in China. Yale University finance professor Chen Zhiwu and Huang Yasheng at the Massachusetts Institute of Technology also predict constrained consumer spending.
Chen estimates the state controls 70 percent of the nation’s assets and says most of its profits don’t flow to consumers. On an inflation-adjusted basis government income surged more than tenfold in the past 15 years while disposable urban income increased less than three times, he said.
Pettis said the drag on consumer spending from depressed deposit rates may help slash China’s annual economic expansion to between 5 and 7 percent a year through 2020, from an average of about 10 percent in the past decade.
The Group of 20 nations has urged China to boost domestic consumer spending to help offset reduced consumption from debt- strapped consumers in the U.S. and Europe. If Chinese shoppers fail to take over that mantle as the government’s 4 trillion yuan in stimulus wanes, then the nation may have to fall back on exports for growth. That would revive trade disputes with the U.S., which is battling 9.5 percent unemployment, said Huang.
“I do not see how trade tensions can be avoided,” said Huang, a professor at MIT’s Sloan School of Management in Cambridge, Massachusetts, and author of “Capitalism with Chinese Characteristics: Entrepreneurship and the State.” “Even in the best-case scenario I do not see household consumption replacing investment as a driver of growth in the foreseeable future.”
China’s leaders have vowed to boost consumption’s share of GDP since at least 2006 -- so far to no avail. The ratio of consumption in China’s economy is about half that of the U.S., and about 60 percent of both Europe and Japan, according to Credit Agricole CIB.
China’s past development has created an “irrational economic structure” and “uncoordinated and unsustainable development is increasingly apparent,” said Vice Premier Li Keqiang in a June article in the government-owned Qiu Shi magazine. Long-term dependence on investment and exports for growth “will grow the instability of the economy,” he said.
Pettis computes the 1.6 trillion yuan in lost returns to savers by comparing the difference between China’s nominal deposit and growth rates to those in other emerging markets. That calculation indicates China’s deposit rates should be at least 4 percentage points higher, he said.
“The government maintains a cap on deposit rates, which helps prop up bank profits, but only by spreading the cost to households in the form of artificially low interest returns,” said Mark Williams, an economist at Capital Economics Ltd. in London who worked at the U.K. Treasury as an adviser on China from 2005 to 2007.
China has left interest rates unchanged since December 2008, even as countries from Malaysia to Taiwan, South Korea and India raised them. The central bank sees little need for an imminent increase, the International Monetary Fund said in a staff report on July 29 after consultation with the Chinese government.
China’s inflation, near a two-year high of 2.9 percent in June, is also eroding household savings. That may cause people to spend less and save more to cover rising costs of healthcare, pensions and children’s education, said Pettis. The one-year deposit rate is 2.25 percent.
In June 2009 savers earned a real return on one-year deposits of 3.95 percent. That slumped to a negative 0.65 percent in June this year, indicating lost returns to savers of 1.8 trillion yuan annually compared with a year earlier. Pettis estimates China’s household deposits account for 60 percent of total deposits, or about 40 trillion yuan.
Chinese investors have few appealing options. Capital controls inhibit citizens from investing overseas. A crackdown on property speculation may cause property prices to fall as much as 30 percent in the next 12 months, according to Barclays Capital. The Shanghai Composite Index, up 0.1 percent as of the 11:30 a.m. local time break in trading, has slumped about 20 percent this year.
Pettis said the 3.06 percentage-point spread between deposit and lending rates that is set by the central bank will help banks pay for potential bad loans after an 18-month lending boom that was almost as big as the U.K.’s gross domestic product.
“Evidence is mounting that the lending spree not only has created bad loans but is now constraining monetary policy,” said Huang.
Concern about potential losses in the financial system may deepen after China’s banking regulator decided to conduct stress tests of the nation’s lenders. The tests include a worst-case scenario of property prices falling as much as 60 percent in cities where they have risen significantly, a person with knowledge of the matter said.
Banks could be saddled with bad loans of more than $400 billion, said Jim Walker, chief economist at Hong Kong-based Asianomics Ltd.
Some economists argue that surging retail-sales figures and rising wages show China’s shift to greater consumer spending is on track. Dariusz Kowalczyk at Credit Agricole CIB in Hong Kong estimates consumption will account for 47 percent of GDP within 10 years.
Retail sales rose 18 percent in the first half of 2010 to 7.3 trillion yuan. Citigroup Inc. says wages in the unskilled labor market may double over the next five years.
“Disposable income levels are growing, the middle class is growing and urbanization is alive and strong,” said Andy Mantel, Hong Kong-based managing director of Pacific Sun Investment Management Ltd.’s consumer-focused Mantou Fund, which invests mainly in Greater China equities. “That would be positive for the next five to 10 years.”
Mantou’s holdings include companies like Fujian-based fruit and vegetable producer China Green (Holdings) Ltd. whose new drinks line is “higher quality than has been available on the market,” said Mantel. “People these days are willing to pay a bit extra for better products.”
Hong Kong-based Nomura Holdings Inc. analyst Emma Liu expects China Green’s stock to rise more than 20 percent over the next year to HK$10.8 ($1.4).
Rising rural incomes prompted Shanghai-based River Fund Management to buy shares this year in Qingdao-based Qingdao Haier Co. Ltd. and Zhuhai-based Gree Electric Appliances Inc., two of China’s biggest makers of air conditioners.
“People nowadays are not only replacing their old air- conditioners, but upgrading from low-end to high-end ones,” said fund manager Zhang Ling. “This will continue over the next 10 years.”
Driven by government subsidies for consumer products including cars and refrigerators, retail sales rose 16 percent in 2009 after adjusting for consumer price changes, the most since 1986.
China supplanted the U.S. as the world’s largest auto market last year as vehicle sales jumped 46 percent. Households borrowed 2.5 trillion yuan, almost four times more than a year earlier.
Even as sales rise, the hope that China was at “a turning point” for the role of consumer spending in the economy may have been premature, said Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics in Washington.
The economy is “still becoming slightly more unbalanced” toward investment, said Glenn Maguire, chief Asia Pacific economist at Societe Generale in Hong Kong. “Until consumption grows faster than fixed-asset investment for a sustained period, the economy will remain unbalanced.”
Urban fixed-asset investment surged 25.5 percent in the first half to 9.8 trillion yuan. Another 29.6 trillion yuan is needed to finish outstanding fixed-asset projects, said Sun Mingchun, an economist with Nomura Holdings Inc. in Hong Kong.
To achieve sustained rebalancing, China should allow a stronger currency that boosts household purchasing power, improve pension and healthcare coverage and gradually allow markets to determine interest rates, the IMF report said.
“I never believed the hype that China was turning the corner on rebalancing growth toward consumption,” said Huang. “The main political agenda is not to let GDP growth slip and that means continued investment growth.”