China Falling? Not So Fast

Photograph by Zhang haiyan/AP Photo

Over the past month, global financial markets have become terrified by the prospect of a Chinese economic slowdown. Last week, the interbank lending rate in China jumped precipitously, suggesting that Chinese banks, which for years have been piling up debt lending to state-owned enterprises and building infrastructure, may now be facing a severe credit crunch. China’s money markets slowed to a near halt, China’s stock markets suffered whiplash, and many Western fund managers began lightening their China exposure.

To some, Chinese banks’ debt loads signal the arrival of an event doomsayers have been predicting for decades—not just a slowdown but a meltdown of China’s economy. That, of course, would be catastrophic for the international economy, since nearly every other country in Asia is dependent on trade with China—as are most Western multinationals.

But although international markets, the original kind of crowdsourcing, often deliver the right verdict, there’s good reason to bet they’ll be proven wrong this time. The Chinese economy, the second-largest on earth, is not going to melt down soon; in fact, it might still grow more strongly this year than most others in the world.

Almost since it began reforming in the 1970s, China’s economy has attracted skeptics. By only partially privatizing massive state companies over the past 20 years, the government has been criticized for creating enormous inefficiencies, building up more than 100 “national champion” companies in such industries as energy, telecommunications infrastructure, and automaking and using cheap credit from state banks to help these indigenous companies grow. These national champion enterprises received the majority of the roughly $600 billion of the 2008-9 Chinese government stimulus package, leading to a new expression in Chinese business circles: Guo Jin min tui (“the state advances, the private sector retreats”).

By also continuing to focus on export-driven growth, naysayers argue, China has remained too dependent on foreign consumer markets. And China’s opaque banking sector has made it hard for outsiders to estimate the total amount of nonperforming loans in China’s four biggest banks.

Since at least the Asian financial crisis of the late 1990s, these critics have regularly predicted that China’s problems would lead to a collapse. In part, these predictions seem almost wishful—perhaps if the Chinese economy collapsed, its authoritarian political system might come undone as well. Over a decade ago, Gordon Chang crystallized these hopes in his book The Coming Collapse of China. More recently, as poll after poll has shown that Chinese urban middle classes, who would be key to any democratization, generally support the government, the wish for economic collapse, leading to political change, has emerged again. Perhaps China-watchers are tired of seeing Western countries run up huge trade deficits and watching China use sketchy trade practices to help out Chinese companies—one American best-selling book last year was titled, simply, Becoming China’s Bitch.

But while China’s economy may slow to less than the 8-10 percent growth it normally averages, a real collapse, to growth rates of 2 percent or 3 percent, or less, is highly unlikely. For one, China’s state and private companies may be getting too easy credit from state banks, but that does not mean these businesses are actually unproductive, like some of the Thai and Indonesian companies caught up in the 1997 Asian finance crisis. The truly unproductive Chinese state-owned and state-linked enterprises were closed down more than a decade ago, by former Premier Zhu Rongji, leaving behind many that are becoming serious international competitors. Chinese companies alone, nearly all of them state-owned, occupied 73 of the top 500 slots in Fortune’s 2012 ranking of the largest companies in the world by sales. China’s score has steadily risen on the Global Competitiveness Index, the World Economic Forum’s ranking of nations’ international economic competitiveness. And several Chinese companies, such as Huawei, have come to dominate global markets like telecommunications.

Overall, China’s real economy, and its job picture, remain strong, compared with nearly every other economy on earth. Even with the credit crunch, the Conference Board, an independent economic forecasting organization, projects that China will grow around 7.5 percent in 2013. In fact, China’s forecasted growth is far higher than that of the average developing country, which is projected at 3.3 percent growth in 2013. (India and Brazil are projected to grow less than 5 percent.) Western nations in Europe and North America would salivate at such growth.

In addition, although China does eventually need a truly convertible currency for its companies to prosper worldwide, its currency is still relatively controlled and its stock markets are not that large. Bad economic news can’t create the kind of runs on the Chinese yuan and Chinese exchanges that damaged such countries as Thailand in the Asian financial crisis. Short sellers, who played a role in bringing down the Thai economy in 1997, cannot do the same to Beijing today. Of course, even if China’s currency were more convertible, Beijing’s enormous hoard of dollars puts it in a far safer place to protect its currency from speculators than Thailand was in 1997.

Most significantly, China’s policymakers have responded to the economic slowdown with clear direction and a willingness to stomach some economic pain for the sake of longer-term reforms. This is particularly noteworthy given that the Chinese people have come to assume that the economy should always steam ahead.

Premier Li Keqiang, the first Chinese leader to have a doctorate in economics, is not just standing idle. From his first speech as premier last year, Li has promised that China’s economy cannot continue to grow without serious reforms. He and President Xi Jinping have publicly admitted that Chinese banks are overleveraged, have vowed to cut the economy’s dependence on debt-fueled easy money construction and informal lending, and have promised to enact policies to boost consumer spending and services. The People’s Bank of China, headed by an acolyte of former Premier Zhu, has shown a clear willingness to let overleveraged Chinese companies fail to reduce systemic bad debts and to make Chinese businesses competitive. Even as the interbank lending rate skyrocketed in mid-June, and many Chinese corporate leaders and traders publicly complained about the People’s Bank’s hawkishness, the Chinese central bank did not inject more cash into the system.

No one is denying that the Chinese economic system needs reforms. China’s economy does need to become more balanced, its banking sector does need cleaning up, its central bank needs a clearer divorce from top political leaders, and its credit system must be made more transparent. But despite all its weaknesses—and to the disappointment of some outsiders—China’s economy is not going to implode.

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