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Bad policy compounds China’s structural slump 

China's economy shows increasing signs of deflationary pressure as consumer prices sink at the fastest pace in 15 years. January's 0.8% year-over-year CPI drop underscores a confluence of negative forces - excess housing, squeezed private firms, and wavering confidence. With GDP growth diverging downwards from official targets, Beijing faces a policy reckoning.


Two issues stand out as suppressing demand and productivity. First, state support continues to flow disproportionately toward inefficient state-owned enterprises, crowding out and depressing private investment. Second, overbuilding has left 150 million more houses than people, suggesting the flood of bad loans flowing through the financial system will be a long-term drag on growth without accepting large-scale losses or the government absorbing some part of the bad loans.


Policy miscues are compounding China's structural headwinds. Premature tightening to restrain debt and property risks is backfiring via defaults and unfinished projects. The resulting loss of investor confidence increases downward pressure. With IMF forecasts more dire than official ones, Beijing is following the authoritarians guide to economic confidence: disagreeing with unfavorable data.


The government’s instincts so far have been to double down on previous policies (like housing support) and pursue half-measures (like cutting reserve requirements) without addressing core imbalances. While direct cash transfers look necessary amid worsening deflation, debt-GDP levels over 287% leave the government with increasingly costly tradeoffs. 


Turning sentiment requires progress on long-delayed reforms - spurring consumption, improving SOE efficiency, and right-sizing real estate. Navigating these squalls will test Beijing's resolve for structural change versus knee-jerk pumps of credit. With the window for effective policy closing, China’s macroeconomic imbalances look like a combination of Greek debt and Japanese demographics.

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