Will new stimulus keep China afloat?

china stimulus

In the last few months the Chinese government has been jumping from a hot spot to another. All this struggling is seriously denting confidence in the stability of the Chinese economy. This, in turn, is exacerbating capital outflows that are draining liquidity in China as well as in other emerging markets. The major problem countries face when liquidity is becoming scarce, is lending. For this reason the Chinese institutions are trying to stimulate the economy by increasing public spending and also recently with the loosening of capital requirements, so basically Chinese banks can cut the amount of money they have to keep in reserve, this move will free-up more than 100 Billion dollars. The problem with China is that we are currently at an inflection point, where new credit is not that stimulative. In fact, years ago Chinese companies were operating with a positive cash flow, the excessive cash was used to pay-off old debts and new debts were issued to cover investing and fuel the expansion of their company. Today, because of an increase in debt and decrease in trading volumes, most of the new debts are used to pay back old debt. It’s a bit like having a patient with a strong headache that has already taken aspirin, more medicine won’t ease the pain and may actually cause more problems. Although the Chinese government has been able to keep things under control, the measures that have been implemented so far will do little to solve the fundamental problems that are affecting the Chinese economy and more pain is on the horizon. Let’s not forget that there are a number of other problems that still haven’t been addressed like for example there are many money-losing state-owned companies that are operating with a massive overcapacity like the steel-making industry or coal mining. In future these companies will be forced to admit reality and cut jobs and default on some debts, causing havoc among Chinese banks. Moreover, mayor investments were destined for real-estate and today we have masses of empty apartments especially in small cities that will need to be filled. To add insult to injury there are also strong currency devaluations among rival asian exporters like South Korea or Japan. This came just when IMF added chinese yuan among its basket of currencies with the promise from the Chinese government not to engage in a currency war. In an attempt to decrease its reliance on exports, Chinese institutions have tried to switch towards a consumption-oriented economy but changes of such scale do not happen overnight and reliance on exports will continue for some time, this means that sooner or later China will be forced to devalue the yuan. More bold moves are needed, Chinese central bank should try to recapitalize the banking system while at the same time, making sure that all this capital will not be used solely for loans to already troubled borrowers. This capital injection should channel credit to private borrowers in productive sectors that will invest this money instead of using it to pay old debts. Moreover, China should give up on industries that are struggling and focus more on the ones that are growing. It’s not going to be easy.

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