If China goes belly-up

Nouriel Roubini, the Cassandra of the mortgage crisis, recently made a prediction about the world’s second largest economy, China:

China’s economy is overheating now, but, over time, its current overinvestment will prove deflationary both domestically and globally. Once increasing fixed investment becomes impossible – most likely after 2013 – China is poised for a sharp slowdown.

Roubini’s thesis is that from 2008 onwards, China’s growth strategy has increasingly been led by fixed investments in large-scale infrastructure projects and real estate, among others. Roubini estimates that fixed investments now constitute 50 per cent of Gross Domestic Product (GDP) with some estimates putting it as high as 70 per cent. Fixed investments-led growth is not such a bad idea if the investments in, say, real estate are conducted by private agents in response to REAL demand for housing which can be fuelled by anything such as an increase in the number of newly weds requiring housing . But the trouble here is that the growth in fixed investments was in large part driven by the Chinese government’s attempt at weathering the global economic slowdown that began in 2008. To this end, the government mandated state banks, flush with savings from Chinese households, to lend to munincipal councils on easy terms so that they could embark on stimulative construction projects, an opportunity the cash-strapped councils did not turn down. If one produces a good in excess of demand, the expectation is that the good’s price will eventually fall. Similarly, Roubini and others claim that there’s presently a construction glut in China which is likely to spark-off a deflationary period (falling prices) in the same manner the housing bubble in the West (US, UK, etc...) burst circa 2007. When this happens, the munincipal governments might witness their sources of revenues drying up making it difficult to service their debts to the State banks setting off a classic banking crisis, which is usually precursor to an economic crisis.

Troubling stories of the unintended consequences of the government’s benign plan to stave off a recession are already beginning to emerge. A recent illuminating piece in the New York Times detailed how one munincipality in China, Wuhan, is saddled with debt after going on an infrastructure construction binge. The trouble here is that the government in Beijing may not be aware of the true extent of the overindebtedness as some of the munincipalities created special purpose vehicles (SPVs) -- a chilling reanactment of the build up to the 2007/2008 financial crisis -- to borrow on the munincipalities behalfs. This from the NYT piece:

In the case of Wuhan, a close look at its finances reveals that the city has borrowed tens of billions of dollars from state-run banks. But the loans seldom go directly to the local government. Instead, the borrowing is done by special investment corporations set up by the city — business entities whose debt shows up nowhere on Wuhan’s official financial balance sheet.

If the likes of Roubini et al are correct in their prognosis, then a likely Chinese slowdown is the last thing that Africa needs. Specifically, a slowdown in Chinese construction might lead to a fall in demand for commodities such as copper and crude, factors expected to drive African growth this decade. For one thing, China is the world’s biggest consumer of refined copper. Further, a Chinese slowdown might deal a blow to the Sino-Africa trade valued at over $120bn  in 2010. There's also other matters of Chinese investment in Africa with a number of projects earmarked for this decade.

Some commentators, however, are of the opinion that the Chinese economy does not face a clear and present danger. If a real estate crisis arises (or is eminent), the planners in Beijing are more than able to steer the ship away from the proverbial iceberg in quite the same way they’ve been successfully steering the economy the last three decades or so. The trouble with this view is that the past is never prologue, and the fact that Chinese munincipalities have created these SPVs right under the noses of the bureaucrats in Beijing casts doubt on Beijing's 'steering' ability. Tough times might indeed be ahead for African economies.