Overheated Chinese Economy
This entry was posted on 7/19/2006 12:42 PM and is filed under Chinese Equity Investments.
One reason why the officials in Beijing feel that their overheated economy is reasonable is because they have few ways to deal with it. In an excellent article in the Financial Times, Richard McGregor points out that of the growth in China comes from companies reinvesting their profits. Unfortunately they reinvest in lines of businesses that they know nothing about, which makes the hope of further profits doubtful. Worse, their diversification increases competition and drives down margins.
Increasing interest rates will not stop this reinvestment. A rise in the renminbi will make matters worse by temporarily encouraging capital inflow, which will be lost by the banks, while decreasing the competitiveness of exports, which will make narrow margins disappear.
The Chinese government could raise rates for deposits to attract some of the extra investment money, but that has two problems. First, it reduces the spread and therefore income for China’s insolvent state owned banks, which get 90% of their income from loans. Third, it will just give money to a dysfunctional banking system that will eventually end up as bad loans.
The reason for many of these problems is the lack of a legal system. Chinese companies do not have any meaningful oversight. They invest in what they choose, pay little or nothing for capital and have no one to answer to but themselves, local officials and 5 year plans. Banks lend on relationships and cannot collect debts. The result is inefficient allocation of capital in every sector of the economy. If problems appear, without free speech, we will not hear about them. In a system without rules, the normal tools of economic management do not apply.
William Gamble
EMERGING MARKET STRATEGIES
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