China's Bank Profits Mask Service-Sector Weakness

The Bank of China headquarters in the Xidan district of Beijing on May 8 Photograph by Mark Ralston/AFP via Getty Images

Is the rebalancing of China’s economy in motion? That’s what China’s President Xi Jinping seems to be saying. “The growth rate could have been higher [than the 7.6 percent recorded in the first half] had we continued with the past development model,” Xi said in a written interview with media from Russia and four central Asian nations on Sept. 4. “We would rather bring down the growth rate to a certain extent in order to solve the fundamental problems hindering our economic development in the long run. In this sense, such a growth rate is the result of sound adjustment.”

So is it time to break out the champagne? Or is Xi just trying to put a nice gloss on the fact that the days of turbocharged economic growth in China are over? One way to gauge that is to look at the service sector, which still accounts for only around 45 percent of the economy, a low level compared with the 70-80 percent that’s common in developed countries, such as the U.S.

A stronger service sector creates jobs, lifts household incomes, and is key to helping the Chinese economy rebalance—moving the country away from an investment-dependent, often wasteful and polluting growth model to a more sustainable, consumption-driven one. And yes, such a change is likely to mean slower economic growth. “The service sector in China is ripe for further development,” said AmCham China Chairman Greg Gilligan in a Sept. 4 press release accompanying a report on China’s tertiary sector.

This week has provided a mixed picture for services, with the release of two monthly purchasing manager’s surveys. First came Sept. 3′s official nonmanufacturing purchasing managers index for August. It’s issued jointly by China’s National Bureau of Statistics and the Federation of Logistics and Purchasing, and it surveys 1,200 companies in 27 nonmanufacturing industries, including retail and transportation. It showed continued expansion for nonmanufacturing companies, albeit at a slower pace, with an index reading of 53.9 in August, compared with 54.1 the month before (above 50 indicates growth.)

On Sept. 4 came slightly more encouraging news from a second service industry gauge, the HSBC China Services PMI, which covers more than 400 private-sector companies. August came in at 52.8, up slightly from the previous month’s 51.3 and its highest level in five months. Still, a subreading measuring jobs was not encouraging. “Employment decreased as service providers saw their profit margins squeezed despite a moderate increase of output prices in August,” Qu Hongbin, HSBC’s chief China economist, said in a statement.

These surveys offer only a snapshot, however, of what is happening monthly. That’s why a recent report by Beijing’s Chinese Enterprise Confederation, which gives a picture of longer-term trends, is so interesting. Published just days earlier, on Aug. 31, it compares the performance of China’s top 500 service industry enterprises and 500 largest manufacturing companies. And encouragingly, it showed that service company revenues this year have grown 15.3 percent, almost double the pace of manufacturers’ revenues. And while manufacturers saw a disappointing 17.47 percent drop in net profit, service-sector profits grew slightly, not a small achievement as labor costs have risen even as China’s economy has slowed.

Dig a little deeper, though, and the hopeful numbers mask a troubling fact: how seeming success in China’s service industry reflects, instead, the performance of a small number of state-owned banks that benefit from China’s only partly liberalized interest rate regime. The spread between deposit and lending rates guarantees banking profits.

The report shows that a formidable 67.5 percent of all profits now generated by service companies have come from just 39 state-owned banks, which in number account for only about 8 percent of the top 500 service companies. And that’s up substantially from a few years ago: In 2009 the portion earned by banks accounted for 58 percent of total service-sector profits. “Extra-high profitability in Chinese banks, most of which are state-owned or state-backed, has raised concerns about structural imbalances in services, a sector that has been attached much importance in steering a growth model away from exports to consumption,” reported finance publication Caijing on its English language website on Sept. 2.

Meanwhile, of the 500 service companies, 15 banks had on average a net profit margin of 23.9 percent; the 485 other nonmanufacturing companies eked out a net margin of only 2.5 percent. A final striking statistic: The profits earned by 286 manufacturers was less than 57 percent of that raked in by China’s five biggest banks, including Bank of China, Industrial & Commercial Bank, and Agricultural Bank of China. The dominance of banks is “extremely abnormal” and must change, the report quoted Chinese Enterprise Confederation Vice President Li Jianming as saying.

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