Editorial: Strengthening Real Economy Key to Risk Prevention
The government’s annual Central Economic Work Conference began Monday in Beijing. The public, especially the business and financial circles, are paying close attention to the meeting, which normally sets the agenda for China’s economy in the coming year. Preventing major financial risks is likely to become one of the major goals of 2018.
It is necessary to carry on with the financial deleveraging. However, deleveraging is only a surgical intervention. As the root of financial risks lies in the real economy, the most effective way to prevent them is deepening reform of state-owned enterprises and boosting the vitality of the private economy.
High leverage often results from the excessive pursuit of growth, as has happened in the past. The 19th National Congress of the Communist Party, held in October in Beijing, de-emphasized gross domestic product (GDP) growth. Instead, the congress said China’s economy has been shifting from high-speed growth to a new phase that puts a premium on high-quality growth. The government has been showing increasing tolerance for slower growth, which creates a positive policy environment for further deleveraging and reining in financial risks.
China’s top politburo leaders held a meeting on Dec. 8 to discuss economic work for 2018. The meeting did not mention expanding general demand like before. Instead, it emphasized that “pushing for high-quality growth is the fundamental requirement when setting development plans, drafting economic policies and implementing macroeconomic controls.”
Officials at the meeting also made preventing major financial risks as one of the government’s three “major battles” for the coming year, along with targeted poverty relief and fighting pollution. More specifically, preventing and resolving major risks requires effectively controlling leverage and corralling the financial services industry so it better serves the real economy.
Many observers believe economic risks in China mainly lie in the areas of finance, local debt and real estate. However, they only see the surface. Financial risks are but a reflection of the risks in the real economy, as the real economy is the root of finance. If capital stays away from real economy and changes hands only in financial systems, it is because the returns in real economy are relatively low. Low returns from investment in infrastructure may also lead to high leverage in the financial sector or in local government debt. On the one hand, state-owned enterprises enjoy endless funding from state-owned banks as a result of the so-called soft budget constraints; on the other hand, the private companies have constant difficulty or have to pay higher costs to borrow money.
Deleveraging is an effective tool for preventing financial risk. But for long-term results, authorities have to focus on more than finance. Maintaining the health of the real economy is vital.
After the 2008 global financial crisis, the Chinese government started an immense economic stimulus program, creating the soaring leverage that accompanied the significant monetary easing. Local governments were encouraged to invest in infrastructure in a spending binge to keep growth rates high.
Government policies need to take effect through “internal variables” such as industrial restructuring or corporate governance. But industries dominated by state-owned companies are often those that require large amounts of capital, produce low returns, and suffer the burden of excess production capacity.
In addition, the state-owned companies’ genes of “soft budget constraints” and insatiable hunger for more funds have made these industries highly leveraged ones. According to the latest estimates of the Bank for International Settlements, China’s debt-to-GDP ratio is about 260%, in which the debts of nonfinancial companies accounted for 160% of the GDP. These nonfinancial company debts primarily belong to state-owned companies. Consequently, deleveraging should focus on the state-owned companies.
In addition to the excessive leverage of state-owned companies, mounting local government debt remains a serious problem. Local governments have been relieving some of their debt pressure by issuing bonds. But it is not promising solution, because many new debts have been hidden under the guise of public-private partnership projects or industrial funds.
By the way, government investments have been on the rise since the beginning of 2016, while private investment has continued to languish at low levels. If this situation continues, the real economy and financial sector will not be able to effectively deleverage. Furthermore, any gains already made in deleveraging might be reversed.
Fortunately, China’s economy has been showing signs of stabilizing, with the new economy sectors making significant strides. To strengthen the momentum, governments at all levels need to push forward reforms to facilitate economic restructuring. First, restructuring and merging of state-owned companies should be accelerated, including the ongoing reform to introduce mixed ownership to state-owned companies. The government should reduce unnecessary subsidies to the state-owned companies and limit the debts carried by state-owned companies and the government. Second, the authorities need to cut funding costs for private companies, break the monopoly of state-owned companies on some areas of the economy and boost the vitality and confidence of private companies. The government has been issuing policy documents in the two directions, but the policies have yet to be carried out so private businesses can benefit.
In the process of deleveraging, the debt-for-equity swap has been seen as a hopeful measure. However, this is not the first time that the government has promoted the measure. The government pushed debt-for-equity swaps on a large scale at the turn of the 21st century. Some wonder what the difference is this time.
The government does emphasize that the latest round of debt-for-equity swaps should be based on the market forces and conducted by legal procedures. Only by following the latest directives can the debt-for-equity swaps have an effect in saving companies that are worth saving, as opposed to extending the last breath of dying “zombie enterprises.”
In essence, deleveraging, reducing risk and promoting reform are the measures on the same page. Over the past few years, innumerable reform documents have been released, and government officials have been touting shining figures in their work reports. But the public feels something quite different. Some have dismissed those moves as “nominal reforms.” Now that the economy is recovering, reform might not seem quite so urgent. However, it is hoped that the Central Economic Work Conference can take solid steps to continue pushing ahead with reform.
The drive for innovation can only grow, and quality economic development can only be realized when reform measures take effect.
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