Chinafotopress

By now, most people are longing for the good old bubble days. Wasn’t it nice? Everything was going up and people were getting rich for no reason whatsoever. Many people trapped in structured products are pinning their hopes on a bubble revival to release them from looming poverty. All eyes are on China's eye-popping loan growth figures. Imagine if all that money goes into the stock and property market. “Wow, all that panda juice! We’re saved!” a friend remarked. Are Chinese banks the kung fu pandas coming to the rescue?

The juice may not be as sweet as you think. As far as I can tell, it’s gone mostly into propping up corporate balance sheets. Loans to property developers have been extended; with unsold apartments used as collateral. Receivables have been replaced with bank loans. The balance sheet expansion of the banking system is to support the corporate sector’s balance sheet expansion. In the four months between December 2008 and March 2009, bank loans rose by RMB 5.4 trillion (USD 791 billion), or 18%. Enterprise deposits, which had stalled due to deteriorating sales, rose by RMB 2.3 trillion during the same period. The money is probably loans coming back to the banks as deposits. The difference between the loan and enterprise deposit growth, RMB 3.1 trillion, is probably the amount that has flowed out of the corporate sector into other parts of the economy.

Why do enterprises borrow and then deposit the money back? The biggest reason is in order to shift unpaid accounts onto banking balance sheets. If one can get full value for receivables notes, one would, of course, exchange them for bank deposits. Second, local governments and enterprises are worried that the credit policy could be tightened. Hence, they secure credit by receiving disbursement now and deposit the money back for future expenditure. Third, the borrowing cost in some cases is lower than the deposit interest rate. Many private businesses have been arbitraging this opportunity.

After subtracting the round-trip lending, the “real” loan growth has averaged RMB 775 billion, which is high but not that shocking. In other words, the loan surge is a liquidity phenomenon so far. A significant chunk of the “real” lending may have gone into paying back wages. An unknown amount of the lending has flowed into the stock market. Subtract these from the RMB 3.1 trillion and the money that has flowed into the real economy appears to have been quite limited.

The loan “surge” may have stabilized the corporate balance sheet, eased social tensions by paying workers and nursed a mini stock market bubble to ease the pain of retail investors, but this is far from creating real demand. And it shouldn’t. The corporate sector already suffers from overcapacity. Why should they pump loans into capacity expansion?

Releasing liquidity to stabilize the economy is a short-term solution. It can’t solve China’s economic problems. China’s invest-and-export model has reached a turning point. Its spectacular export growth in the past five years has been partly due to the global bubble. As the bubble deflates, China’s exports are normalizing. More seriously, China’s base is simply too big, relative to the world, to grow rapidly in the future. This suggests that, unless a new growth model is found soon, China may experience low growth for years to come.

China is an export-driven economy. If the global economy stays weak, which is likely for the next five years, China must undertake big changes to achieve high growth through a different model. The key is to boost household demand.

However, household demand is low, because household income and wealth are low. Unless both causes are addressed, talk of a stimulus is wishful thinking. China has been trying to stimulate consumption for a decade. If stimulus was the solution, it would have happened already. Consumption coupons, for example, have a temporary and localized impact. Even filling up the social security fund or providing universal health care wouldn't solve the problem.

But two policies could change the situation immediately. First, China should aim to lower property prices to 1-1.5 month’s salary per square meter. This level is not low by international standards, but would reduce the financial burden on households enormously. Now, when a city-dwelling man wants to marry, three generations have to pool money for a home down-payment. Such a heavy financial burden severely cuts into household consumption. The government is in a position to reduce property prices, since more than half of the purchase cost goes to the government in land costs and taxes.

Second, the government can distribute its shares in listed state-owned enterprises to the household sector. Such a large transfer would make everyone a stakeholder in the market economy, which would ensure stability for decades to come.

The wealth transfer could sustain high consumption growth for years, which would result in a good labor market and rising wages, further fuelling consumption.

China must play its cards right to bring back high growth, despite a sluggish global economy. But it takes real reform, and that takes time. I suspect many are hoping for the easy way out: talk it up, investors jump in, and we are back at the races. But, this time, I’m afraid it’s different. Only reforms can bring back high growth and the bull market. Panda kung fu moves won’t work.