China's Growth Risks

Editorial do WSJ

The Chinese economy is coming in for some sort of landing, and everyone is speculating whether it will be hard or soft. After HSBC on Monday released a purchasing managers index barely in positive territory, Goldman Sachs yesterday lowered its growth forecast for the year to 9.4% from 10%. But the determining factor in the hard vs. soft debate, and one reason global markets have fallen out of bed this week, is that Chinese inflation continues to accelerate. Goldman predicts an annual rate of 5.6% in June, up from 5.3% in April.

If you believe the government and some independent analysts, this isn't a big deal because inflation will peak this quarter. A couple more hikes in bank reserve ratios and perhaps one more quarter-point rise in lending rates and prices will stabilize.

Maybe that will prove true, and the world will breathe a sigh of relief. Yet it's also worth considering the possibility that Beijing has backed itself into a monetary corner. The central bank has already used up most of its ammunition for fighting inflation, yet money continues to pour in on both the current and capital accounts. As a result, a chunk of the People's Bank of China's intervention in the forex markets to keep the yuan's value stable is unsterilized, meaning it goes straight into the money supply. The fact that real interest rates remain negative shows that for all its alleged tightening, monetary policy remains loose.

When the economy is growing quickly, that's not such a problem, as the new money has increasing amounts of goods to buy. But slowing output leaves more money chasing fewer goods, the classic cause of inflation. The conventional wisdom that governments stop overheating by constraining growth is turned on its head here.

The fragility of the global economy only adds to the angst. Asia-Pacific nations especially have become dependent on China for much of their growth. The last time China's growth slowed significantly, in the late 1990s, its trade was still too small to exert much of an impact beyond its shores. Now it is the world's second-largest economy and second-largest trader.

This means the world must pay close attention to Chinese fundamentals, including the stability of its banking system. Beijing will no doubt continue to insist on the principle of noninterference in its internal affairs, but there is a pressing need for greater transparency. As the Journal reports, China is the biggest player in the global steel market, yet nobody has a clear picture of how much it produces and consumes. The financial system is even more opaque, as official data are suspect and information that would be public elsewhere is still considered a state secret.

Officially, the large state-owned banks have reduced their nonperforming loans dramatically, to 300 billion yuan ($44 billion) in 2010 from more than one trillion yuan in 2005. But the government spurred the banks to lend 1.4 trillion yuan in 2009, and even the optimists concede that some portion of these loans are starting to go south. There are many ways to disguise this fact, as Japanese bankers can testify, and so the question is whether investors can trust the balance sheets of banks that are simultaneously arms of the state and listed companies.

Beijing may engineer another growth spurt by calling on the banks again to spur lending. But it's clear that China's growth model is reaching the limit of its usefulness. Sooner or later the central bank will have to halt its accumulation of reserves and the expansion of the money supply. That will deal a shock to the economy, but it will be better than continuing down this road toward a bigger crisis and recession.