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China: Slowing growth rates not Beijing's biggest worry

18 July 2013

By Peter Main

In July it has become traditional for China’s leaders to leave behind the heat and smog of Beijing and head for the seaside resort of Beidaihe. No doubt today’s mandarins know how to enjoy themselves, but this is no holiday trip. Over the next few weeks the new government team under Xi Jinping and Li Keqiang will be trying to get a grip on a range of fundamental problems that have been accumulating for years.

Recently published economic statistics have confirmed that growth rates in China are slowing down. From a peak of 14.2% at the height of the last cycle in 2007, the figures for the second quarter of this year, out this week, point to an annual growth rate of 7.5%. That the trend to slower growth is not likely to be reversed can be seen from the National Bureau of Statistics’ Purchasing Managers’ Index, PMI, for manufacturing industry; in this, a figure above 50 points to expansion and the historical average for May is 53. This year it stood at 50.8, indicating only the most anaemic growth.

These figures are bad enough but, thanks to Wikileaks, we know that the leaders themselves take them with more than a pinch of salt. In 2010, Li was reported as saying that GDP figures were “for reference only” and that he himself relied on figures for electricity consumption, rail cargo volumes and loans when assessing economic development. According to a widely quoted article in the Wall Street Journal, Stephen Green of Standard Charted reported that his own calculations indicated GDP growth of some 5.5% for last year rather than the officially reported 7.8%. Similarly, the PMI figure calculated by HSBC for May this year was 49.2 and declined to 48.2 in June. In other words, there may actually be a shrinkage in output from manufacturing.

Evidence of more distortions in official figures that mask a reality of growing economic difficulties can be found in import and export figures. In April of this year, it was reported that there had been a year on year growth of 14 per cent in exports, a very healthy figure given the acknowledged slowing down in world trade. However, the year on year figure for May showed only 1 per cent growth, a remarkably abrupt downturn which was later explained as a result of a tightening of accounting procedures. It transpired that earlier figures had been inflated by companies falsifying export figures to cover up foreign exchange dealings. Under the new rules, the year on year figures for June showed an actual reduction in exports of 3.1%, as compared to the anticipated increase of 4%.

These figures underline the continued importance of export oriented industry for China’s overall economic development. This is not just a matter of the profits made on exports, the sector employs some 200 million workers, more than half of the urban working class, and their expenditure on housing, food, clothing, transport etc constitute an important component of the “domestic” element of GDP.

Disturbing as these statistics may be, however, they are unlikely to be the centre of attention in Beidaihe. Both Chinese officials and foreign commentators see them as an inevitable consequence of the decline in markets for Chinese goods in North America and Europe. Far more worrying is the prospect of a serious financial crisis within China.

That all was not well was revealed dramatically on June 17 when the central bank, the People’s Bank of China, raised overnight credit rates to 25%, inducing a “credit crunch” reminiscent of the aftermath of the collapse of Lehman Bros in 2008. On this occasion, however, policy was relaxed within a matter of days although the interbank rate in Shanghai has remained at almost twice the level of early June.

Such a big rise in short-term credit rates would normally be a response to fears that a major financial institution was in serious difficulty, and unable to repay its debts. As with Lehman Bros, since no one can be sure of the consequences of a major default, all credit dries up. This may, indeed, have been the case in June; some days later Bloomberg reported that the PBoC had provided $8.2 billion (£5.7bn) in support for the Industrial and Commercial Bank of China, nominally the world’s largest bank. However, the consensus of expert opinion is that the credit crunch was created deliberately in order to dampen down borrowing and as a first step to regaining control of the country’s rapidly expanding debt. According to the ratings agency, Fitch, total debt in China was the equivalent of 200% of GDP by June this year.

In particular, the authorities were probably targeting the so-called “shadow banking” sector. This refers to a very broad range of bodies that provide credit that is not subject to the regulations of the official banking sector. Nonetheless, according to Charlene Chu, Fitch’s Director in Beijing, as much as three quarters of all shadow banking actually involves the main banks. In order to get around official restrictions on lending, and on interest rates, the banks have developed a range of techniques to take loans off their balance sheets.

Writing in the South China Morning Post, Zhang Monan reported that such off-balance-sheet lending outstripped on-balance-sheet lending in 2011-12, growing by CNY1.1 trillion (c£117bn)to reach a total of CNY3.6 trillion, (c£388bn) 23 per cent of total bank lending, while on-balance-sheet lending only grew by CNY732 billion (c£80 bn).

Apart from the banks themselves, probably the most important sources of credit are trust companies, of which there are 67, that take in money from investors and lend it on to borrowers. Unlike banks, they do not hold deposits so, unlike banks, they have neither a capital reserve nor, like the state banks, a safety net in the form of state backing so, if loans cannot be repaid, the trust, and its investors, stand to lose their money. This, of course, means that such companies have had to develop considerable commercial and financial acumen and their interest rates on loans reflect the calculated risk. The advantage, across the shadow sector, is that interest rates for both investors and borrowers are not subject to state controls and funds can be provided to businesses that, for one reason or another, cannot obtain credit from the official banks. This is often the case for private businesses.

One of the main routes by which companies and local government bodies can access credit is via a range of financial mechanisms, known as “Wealth Management Products” – WMPs. Typically, a loan made by a bank at above official interest rates is sold on to a trust which then repackages it as a WMP, an “investment opportunity” offering lower, but still attractive, interest rates to investors (who are often the general public). This takes the loan off the books of the bank and, providing the initial loan is repaid with interest, the investors get their money back with interest. Generally, such loans are relatively short term, up to two years, and repayments are timed to coincide with the banks’ auditing schedules. By choking off credit when it did, the central bank may have intended to make sure that the CNY1.5 trillion (c£162bn) of WMPs that were due for repayment at the end of June were not simply refinanced by further borrowing.

The huge sums of money made available through the shadow banking sector have been a major factor in creating speculative bubbles both in the stock market and in real estate. They have also been used by ocal government bodies to finance sometimes huge construction projects that are unlikely to be commercially viable so that the loans taken out to pay for them will not be repaid. It is this prospect that will be exercising the minds of China’s leaders in Beidaihe. The very close links between the shadow sector and the official banks mean that a serious default, for example, of one of the trust companies, would have repercussions throughout the economy, creating a credit crunch that could not be so easily brought to a halt by the central bank.

Even a brief overview of this aspect of China’s emerging financial system makes clear the scale of the funds involved and the complexity of the matrix of linkages between finance, industry, commerce and politics that has already been created. More fundamentally, it illustrates in a practical context how a new Chinese bourgeoisie is being created within the still existing framework of a highly state-controlled economy.

What is clear is that the process of class differentiation is still very far from complete, and this is not surprising. The actual people involved had their origins in a China that was still a degenerate workers’ state, a bureaucratically planned economy. Many will have begun to accumulate their wealth by exploiting their positions or family connections within the party and state apparatus in the Nineties, and many still do – while others are increasingly independent and find continued state controls, such as those on banking, a real obstacle to the maximisation of their wealth.

China’s economy is still dominated by giant corporations that have very close links to the state and party. The main banks are, indeed, still state-owned, but even where formal state ownership has been given up, a range of advantages such as low interest bank loans and preferential state procurement policies, as well as the institutional inertia that maintains pre-existing economic relationships, all combine to favour the companies that were previously state-owned.

Not surprisingly, this has led to characterisations of the Chinese economy as “state capitalism” or “bureaucratic capitalism”. The danger with such labels is that they imply that what exists today is in some way a finished model, a particular “kind” of capitalism that is somehow unique and may, or may not, prove to be more successful and dynamic than other “models” of capitalism. This would be a mistake. In reality, the dynamics of the Chinese economy and the institutions and social relationships it underpins are still unfolding. It is, so to speak, still a “work in progress” that is very uneven and combines elements inherited from the old planned economy with new elements of developing independent capital.

As Marx pointed out, capital is, at root, not a technical or economic category but a social force. According to a report from the State Administration for Industry and Commerce, there are now 40.6 million individually owned enterprises in China and they control CNY2 trillion (£216 billion) of capital and employ about 80 million workers. Clearly, while the numbers are impressive, this is a sector characterised by small firms employing handfuls of people, probably a high proportion being family members. Nonetheless, that is 40 million families, a total population bigger than that of the UK, for example, dependent on maximising the return on their capital.

These are precisely the small firms that cannot obtain loans from the state banks and have to rely on shadow banking in one form or another to finance development. Theirs is a world that would warm the hearts of neo-liberal theorists everywhere, a very raw capitalism in which every cent is counted and every opportunity, and person, is exploited to the limit. Some will be very successful, many will not. They are undoubtedly one element in the creation of a new capitalist class but, as yet, they are small scale, scattered and far from a decisive social force.

More important, in social and economic terms, is the “private sector” as distinct from the “state sector”, that is, firms that are privately owned but including large companies operating on the world market, rather than merely individually-owned businesses. In a report broadcast by state TV on June 2, the All-China Federation of Industry and Commerce gave a figure of 10 million businesses in this sector and claimed that they were responsible for 60 per cent of China’s GDP. That is a force to be reckoned with.

This is the sector in which the demands of business interact directly with the rule of the bureaucracy. Production and services on this scale obviously require close collaboration not only between different firms in a chain of production but also with local, provincial and even national, government and, inevitably, banks. This is where off-balance-sheet loans from state banks, whose regulations would not allow them to be made as part of the regular business, are the norm.

Although the explosion in this shadow banking has created an enormous overhang of debt nationally, it is not difficult to imagine that all involved in this sector, manufacturers, service companies and bankers, see such transactions as not only necessary but sound business. Indeed, according to Chu, the majority of such loans are actually better guaranteed than those on the balance sheets of the banks and make better business propositions than the “soft” loans extended to the state sector.

The capitalists in this sector, then, have already gone a long way towards identifying their common interests as against those of wider society. They are supported in this by their links to economic research institutes, academic faculties and their relations to the international capitalist system from which they gain both comparisons and expertise. In Marx’s terms, they are much closer to being a class “for itself”.

It might be supposed that the “communist” leaders will use their time in Beidaihe to perfect plans for regaining control of this unruly element, clipping their wings while also deflating the dangerous credit bubble through carefully calibrated regulatory attacks, such as the “credit crunch” of June 17. The reality is likely to be quite the opposite.

President Xi and premier Li certainly intend to stay in control but, as we have emphasised before, they represent a faction within the Communist Party that is committed to further relaxation of controls on capital and greater concessions to China’s capitalists.

Their answer to the contradictions between state ownership and regulation of the banking system and the less regulated shadow system will be to begin dismantling the regulatory framework. In essence, it seems, they accept that the shadow sector is more businesslike and potentially more efficient as a means of directing capital flows to the most advantageous locations than the regulated system with its preferential treatment of state owned enterprises.

They do not, however, intend any “big bang” strategy or a sudden bonfire of regulations. As with earlier stages in the restoration of capitalism, they will proceed by experimentation, allowing the development of a “deregulated” enclave of free banking alongside a continuation of the present system in the rest of the country. As experience is gained, so deregulation will be extended to other regions. This echoes the experience with the creation of the Special Economic Zones, SEZs, in the Eighties and Nineties in which overseas capital could invest in production using Chinese labour and resources but only for export. It says a great deal about modern China that the architect of the SEZ’s was Xi Jinping’s father.

Such careful experimentation should not be taken to mean that they are thinking small; this will not be a hole in the corner operation in some obscure region. On the contrary, they are planning to establish a “free trade area” for banking and futures trading in the very capital of Chinese commerce, Shanghai or, to be more precise, in the new city of Pudong, across the river from Shanghai.

In this area, foreign banks will be allowed to set up shop without any of the extremely slow procedures previously required. They will also be allowed to form joint ventures with Chinese banks, both private and state owned, and even be allowed to hold majority stakes in such ventures. The intention is to bring in not only international expertise, which can then be generalised to other regions, but also foreign capital to compete with domestic banks, thereby, it is hoped, strengthening them in the long term.

It is not difficult to see that the banks in this “zone” will find it easier to do business with the “shadow banks” than with the still tightly regulated state banks. Also, in the longer term, the plan envisages Shanghai becoming a “regional finance centre”, that is, a centre for the whole Asia-Pacific region, not just for that part of China.

In its own way, this confirms the League’s analysis that China has now established itself as an imperialist power. It first achieved that status on the basis of its colossal manufacturing and trading role in the world economy and confirmed it by withstanding the impact of the financial crisis of 2008-9 far better than its rivals on the world stage. Unlike the development of earlier capitalist imperialisms, in which initially quite separate industrial and banking sectors evolved into a fused “finance capital” sector that dominated whole economies, China’s unique path of development from a degenerate workers’ state saw manufacturing industry grow under the control of an already existing state banking regime.

More recently, and under the impact of the world crisis, the industrial capitalists who developed under the protection of the state, have found it necessary to establish a new relationship with the banking sector in the form of “shadow banking” in which both sectors evade state controls in order to pursue what they see as the optimum business plan. Whatever the legality of this, the fact is that this is actually closer to “real” banking than is the official banking sector.

The decision by the party leadership to begin to legitimise what is currently “shadow banking” is not just a matter of accommodating to reality, there is a much bigger purpose to it. A banking sector that decides on loans only on the basis of commercial considerations, and is sufficiently skilled and capitalised to enforce its standards across such a huge economy as China, is a precondition for finally removing the “advantages” still enjoyed by the state owned sector of industry.

Subordinating the state sector to “market forces” would undoubtedly mean restructuring some of the world’s biggest banks as well as giant corporations such as those in the oil and chemicals industries. Some parts will probably be driven into bankruptcy and their assets sold off cheaply, others may be wholly or partly privatised. Whatever the particular procedure, the prospect of getting their hands on such resources will no doubt embolden China’s new bourgeoisie.

Whether or not they already have the social weight to force such a policy through, remains to be seen. There will certainly be powerful vested interests opposed to them, especially within the party and the state bureaucracy. It is reported that Li Keqiang, who is in charge of the Shanghai Free Trade Area project, had to overcome stiff resistance to his plans before they were finally endorsed by the State Council on July 3.

As well as rival factions within the party and state, two other factors could delay, divert, or even prevent, the intended scenario from playing out. The first of these is the dynamic of the actually existing system in which declining world trade means declining profits and, therefore, increasing likelihood of major debt defaults in China. Given the magnitude of debt on a national scale, any such event could trigger a chain reaction of company and bank collapses and, as a result, a major cyclical downturn.

Secondly, and even more fundamentally, there is the response of the Chinese working class as events unfold. In the immediate aftermath of the 2008 crisis, there were widespread mass actions such as strikes, occupations and blockades of whole cities or transport routes that forced the state authorities to at least compensate workers for unpaid wages or redundancy. As the economy recovered, workers were able to exploit labour shortages to force up wages by as much as 20 per cent per year. Advances have even been made on the organisational front as a result of strikes such as that at Honda in Foshan where workers insisted on electing their own negotiators.

How workers in the export industries would now defend themselves in the face of a downturn caused by continued shrinkage of export markets or a major financial crisis, or how workers in the currently state owned sectors would respond to restructuring, rationalisation and privatisation, is impossible to know. What is certain is that, one way or another, their interests will clash with those of China’s capitalists and the mandarins currently plotting their next moves in Beidaihe.

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