-Caveat Lector- Far Eastern Economic Review
THE ECONOMY China Public Spending Explodes The government is spending much more than it can raise to make new jobs, stimulate growth and ensure social stability. But as the budget deficit soars and the problem of bank debts isn't solved, warnings are growing that it may all end in disaster --------------------------------------------------------------------------- ----- By David Lague/HONG KONG Issue cover-dated January 30, 2003 --------------------------------------------------------------------------- ----- THE FIRST SHOVELFULS of dirt are being thrown in one of the world's biggest public-works projects: Channelling water from China's Yangtze River to the parched Yellow River in the north. The planned expenditure: $59 billion. Track-laying teams are driving through mountains and across China in a race to add 7,000 kilometres of new railway line by 2007. The budget: $42 billion. Work has already begun to modernize Beijing for the 2008 Olympic Games. Estimated spending: $34 billion. Shanghai officials say they will keep up the pace of expanding public facilities in 2003. The cost: $6 billion. Tally it all up along with thousands of other infrastructure projects driving economic growth in China and it makes a massive bill for today's taxpayers and, increasingly, debt for future generations as well. BUDGET BLOW-OUT . The government is keeping China busy with thousands of big public-works projects . Their cost is running up record budget deficits . Fears are rising that the combined pressures of soaring public spending and debts at state banks may lead to a financial meltdown China's public spending is steadily outstripping its capacity to collect revenue. And experts are beginning to sound the alarm as government debt rises sharply to meet the shortfall. Foreign experts fear that the short-term benefits of this flood of public-sector deficit spending--fuelling growth and producing enough jobs to head off social unrest--could be outweighed by the longer-term costs. Even official voices in China have started to warn of trouble ahead. "This is surely not sustainable economic growth," wrote Zhao Xiao, a researcher with the State Economic and Trade Commission, in a December article in Beijing's China Business Times. "China is running towards a 'fiscal deficit trap'." Even some of the most optimistic observers of the China boom are viewing the ballooning government debt with trepidation. Andy Xie, managing director of investment bank Morgan Stanley in Hong Kong, is a renowned China bull, but he now cautions that a financial meltdown could become "inevitable" without major reforms of the system. "China's current growth model depends on exports to generate liquidity, foreign direct investment to fuel export production and debt funding to build infrastructure," he wrote in a January report. "This model can continue for another five years, but in five years the level of debt may become too high and could trigger a financial crisis." The World Bank warned last November that Beijing faced a challenge keeping its budget deficit beneath the internationally accepted danger level of 3% of GDP. Government economists now estimate that last year's deficit easily exceeded 3%. The Organization for Economic Cooperation and Development (OECD) noted in a report in November that Beijing's figures on overall indebtedness were "misleading" and China had only limited scope for fiscal expansion to raise money. Beijing's bid to keep buying economic growth with huge public spending is a dangerous race. And the future stakes may be much higher than just a poor return on investment for taxpayers. No one doubts that for China to grow, it needs more roads, harbours, research laboratories, telecommunications, water supplies and energy. The question is, how much infrastructure spending can the country afford when the government at some point will need to bail out virtually insolvent state-owned banks and provide for gigantic pension liabilities? "It appears that China's leaders are embarking on a dangerous gamble," says economist Christopher Lingle, an authority on Asian financial systems for corporate-risk consultancy eConolytics.com. Unofficial estimates of government liabilities including budget shortfalls, foreign borrowings, nonperforming loans and pensions range from 70% to more than 150% of China's $1.2 trillion GDP. And Beijing may soon be paying up again to shore up its banks. The semi-official Business Post said on January 18 that the government was weighing whether to inject $40 billion in capital into the big four debt-burdened state banks. Hong Kong's South China Morning Post put the recapitalization at up to $72 billion. In 1998, Beijing put $33 billion into the banks. A year later $169 billion in NPLs was transferred from them to four state-owned asset-management companies. After years of low or nonexistent budget deficits, China began serious pump priming in 1998 to maintain economic growth and counter deflation. It was also aimed at building the infrastructure that the economy needs for development and to provide jobs for the growing army of unemployed. Agricultural reforms from the late 1970s had led to a growing pool of underemployed farmhands. The disintegration of inefficient state-owned enterprises swelled the ranks of the urban jobless. Some analysts estimate there may be up to 270 million unemployed or underemployed in China. But strong economic growth of 8% in 2002, according to official figures, has failed to dent unemployment, which poses a major threat to social stability and to the survival of Communist Party rule. Deflation remains a problem and analysts expect oversupply to continue to weigh on prices this year. There is no doubt that spending on infrastructure helped ease some of the threat from unemployment, at least in the short term. No visitor to China can fail to notice the gangs of workers building roads, bridges, dams, container terminals and airports. And economically vital infrastructure is in place--though doubts are increasing over the value of some projects, including the $25 billion Three Gorges Dam. On January 20, the Berkeley, California-based International Rivers Network accused authorities of mishandling the resettlement of hundreds of thousands of people being moved for the project. "Local authorities appear to have diverted a large part of the resettlement budget into unrelated infrastructure projects, using funds intended for household compensation on projects like hotels and roads," the environmental group said. In another example of a top priority project cited by supporters of public spending, China boasts a highway network second in size only to the United States' road system. The price is a sharp deterioration in the government's fiscal position. In 1997, China's budget deficit was about 0.78% of GDP, according to official figures. That jumped to about 2% in 2000 and easily grew past 3%, or $37.5 billion, for 2002, according to most estimates. Along with treasury bonds sold to finance this spending, China has also issued special long-term bonds worth about $80 billion to fund infrastructure projects. It plans to sell another $17 billion this year. With the deficit now above the danger level, top officials including Premier Zhu Rongji and Finance Minister Xiang Huaicheng are signalling the need to rein in spending and curb waste on projects. "Fiscal expenditures must guarantee priorities and spending on general purposes must be strictly controlled to help limit the size of the budget deficit," Xiang was quoted as saying in the official China Securities Journal in December. Part of the problem is that the tax system has failed to keep up with spending. In its November update, the World Bank said preliminary estimates showed that spending last year increased beyond the 11% target set in the budget while revenue collection fell short of the projected 10% increase. This prompted a national drive against tax evasion. In its report, the OECD noted that tax collection had fallen as a proportion of GDP between 1980 and 1996. There has since been some recovery, but it is still less than 15% of GDP. Perhaps the real test for Beijing will be when it bites the bullet and really tries to restore the four big state-owned banks to health, a step that most international agencies consider is urgently needed. Estimates of the cost to bail out the banks range from $200 billion to $600 billion. This will also eventually be borne by the taxpayer. Together with unfunded pension liabilities estimated at 50%-100% of GDP, these obligations will put enormous pressure on Beijing to curb its spending. Even so, it might not be enough to avoid a financial crisis that would wipe out much of the progress from two decades of economic reform. Some experts believe disaster is still avoidable, but the longer the spending spree lasts while true banking reform is delayed, the greater the risk of collapse. <A HREF="http://www.ctrl.org/";>www.ctrl.org</A> DECLARATION & DISCLAIMER ========== CTRL is a discussion & informational exchange list. Proselytizing propagandic screeds are unwelcomed. Substance�not soap-boxing�please! 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