by Nicholas R. Lardy, Peterson Institute for International Economics
Op-ed in the Wall Street Journal
June 23, 2010
© Wall Street Journal
Among the most widespread criticisms of China's stimulus program is that it is financed not with increased budgetary outlays but rather with a massive increase in bank lending. The increase in loans outstanding in 2009 was a historic high of 9.6 trillion yuan ($1.4 trillion), almost twice as great as 2008. The critics charge that inevitably the quality of lending must have declined and that Chinese banks are likely to face a growing mountain of nonperforming loans. In this view, dealing with this glut of bad debt ultimately will require another central government injection of public funds into the banks, setting back China's transition to a commercially oriented financial system.
The only problem with this theory is that there isn't much evidence to support it. Upon closer inspection, the explanations offered for why China's credit expansion will lead to a banking crisis either don't match the facts on the ground or don't fit with China's current level of economic development.
Consider the first of two versions of the nonperforming-loan doomsday scenario. This conventional wisdom holds that much of the increase in credit was channeled to state-owned firms in traditional industries like steel. Massive investment in these sectors, the thinking goes, is creating excess capacity that will put downward pressure on prices. This in turn will impair firms' profitability and their ability to repay their loans.
The facts say differently. Bank lending to traditional state-owned industries last year was relatively small. The best evidence is the allocation of the medium- and long-term loans, which accounted for half of all bank lending. Only 10 percent of these loans, which are used to finance investment, were channeled to the manufacturing sector in 2009. Thus while total national investment rose by more than 30 percent, investment in the steel industry rose only 3 percent. Steel investment last year appears to have been financed primarily by retained earnings rather than increased borrowing.
Far and away the most important destination for credit was infrastructure, which attracted just over half of medium- and long-term lending last year. Local-government investment companies undertook a large number of new road, subway, water, and other projects. This leads into the second iteration of nonperforming-loan alarmism: That these costly infrastructure projects lurking off local-government balance sheets will place enormous strains on government finances and eventually force Beijing to bail out the banks as a result.
That is most likely to be a problem if governments truly are not building economically useful infrastructure. Governments have two options to repay these loans. They can recoup sufficient usage fees like road tolls. Or they can count on the infrastructure to spur other economic growth that will boost tax revenues. The banking skeptics believe neither of these conditions will be met by many projects.
Yet that concern is misplaced or exaggerated. World Bank research shows that the marginal productivity of infrastructure in most emerging markets exceeds that of other physical capital. While China's infrastructure is more advanced than that of most countries at a similar level of development, it ranks only 27th internationally in the World Bank's 2010 analysis of global trade logistics, which measures infrastructure development and customs efficiency. Clearly there is scope for many more economically productive infrastructure projects in China.
Critics might charge that the haste with which so many projects have been built in the past two years means governments haven't taken the time to separate the worthy projects from white elephants. But it's hard to draw any clear generalizations. For instance, China's signature national stimulus projects, the expansion of the rail network (including the 16,000-kilometer high-speed network), is part of a 15-year plan approved by the State Council seven years ago.
Meanwhile, government likely has additional scope to raise fee revenue from high-value infrastructure that is currently underpriced. Water and subway services in major areas, for example, are significantly cheaper than the market would probably bear, calling into question the ability of local investment companies to service their debt related to these services. But this financial problem eventually will be solved. The government can raise the price of services to cover costs. On the tax side, local governments can acquire new revenue sources, such as a property tax, that will provide the fiscal resources to repay the loans those governments have guaranteed.
The decision of China's leadership to ramp up infrastructure investment last year made sense as a short-term response to offset the drag on growth caused by the global recession. Given appropriate reforms of services pricing and a broadening of the local tax base, the dramatic increase in lending for infrastructure need not lead to a banking crisis. That does not make the scale of last year's infrastructure-centric stimulus sustainable over the long run—China still will have to accelerate the transition to consumption-driven economic growth. But it does mean that policymakers may have to worry less than some think about cleaning up from the last stimulus.
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