China's Local Government Debt Crisis - Essay Example

China’s Debt China’s Debt The large debt in China started accruing in the year 2008 during the global financial crisis. Unlike other states, China decided to evade the crisis through a stimulus program launched in 2009 (Naito, 2012). The Chinese economy increased by about 1.1 trillion dollars. The purpose of this stimulus was to elevate the economic crisis in the country by increasing investments in the public sector. This situation, however, led to high levels of Chinese debts (Kim, Tan & Yurim, 2013). China used its political leaders to force the state banks to lend capital to projects that were unjustified. The largest banks in China lent more than twice the level of bad debts in the year 2013 as they had in 2012 (Jadhav, Neelankavil & Andrews, 2012). Australian banks have lent China an alarming 75 percent more than their usual amount. Their aim, however, is to gain exposure to Asia’s economy in the powerhouse sector. The World Bank has also been a major lender to the Chinese government but on concessionary terms. These finances, however, arise from indirect contributions of the United States, which is the largest contributor to the World Bank. The finances from China are round- tripping as the U.S. massively borrows from China. China has used its borrowed funds, which are mostly Chinese-owned, in the public sector. Some of the national projects that China has involved itself in using the borrowed funds are the construction of sundry new buildings (Koo, 2013). These constructions include homes and offices, some of which are unoccupied over the years. According to the State grid, the new constructions have zero billing on electricity. The established investment platforms for the local government in 2009 have led to a high increase of the outstanding debt by nearly 70 percent. China’s debt also funded several investments in infrastructure (Bailey, Huang & Yang, 2011). These include roads built in 2011. Infrastructure was more profitable than the boom of construction of houses in China. The Chinese situation of being a state with so much debt has had both positive and negative effects on its people. Due to the construction of new houses by the state in 2011 in a bid to try to evade the economic crisis that hit the world in 2008, property prices increased. The nationals had a problem measuring up to this change. The local government raised interest rates of bonds in the money market in China. The inflation increased in the country characterized by increased loan screening (Liu, 2010). The debts have led to declining economic growth in the country with a prediction of the growth being low than 5 per cent in the year 2014. The declining growth in the economy of China has made unemployment level in the country to increase to worrying rates. The Chinese leaders fear that people will end up taking to the streets because the unemployment rates are reaching dangerous rates. On the positive side, the leaders and politicians of China benefit from the situation by being excessively wealthy due to the usage of the borrowed funds. They, therefore, have little impetus to change the situation. To manage its current challenge of having too much debt and a falling economy, China needs to develop reforms that will put it on the right track. It may be impossible to return to its former glory of being the second largest state with the highest Economy, but it can introduce measures to help set it on the right track. China has had the pride of notching a 10 percent GDP boost performance annually, but it only attained 7.7 percent, this year. To deal with these disadvantages, the financial system of the country needs to stop the emerging trait of shadow banking. Mysterious and unconventional lending sources to the central government have been maintained by the state banks. These finances lent miss from balance sheets of the bank. A policy that China can adopt in its economy is to allow consumption to play a bigger role in its economy. China currently operates on a state-led, investment founded economic environment. The warnings of Economists are that China should reduce its dependence on growth by investments and redirect its focus on consumption by the public. China has not been friendly to consumption because the public saves most of their income in order to fund their weak health care systems and pension schemes (Zhang, 2012). They are in turn punished for saving by receiving meagre returns for their savings because the interest rates in bank deposits accounts are discouraging. China biggest current problem is the debt it has accumulated over the years especially since the year 2008. The purpose of the debt was to keep the investments in the country as before the crisis, but this led to even more debt problems of the country (Sevic & Jiali, 2013). The outcomes of this have seen the economy of China spiraling down. It has been unable to maintain the same increasing GDP over the years and the unemployment rates in the country are down with its labor force decreasing at a steady rate because of the one child policy it had adopted. The criteria with which to evaluate the shadow pricing and increased investment outcome are limited funds, economy growth strategy and China’s position in the economic chart. China has had to deal with an impending global downfall when there was an economic down hit. It had to avoid this situation by borrowing finances from state owned banks in order to finance its operations. The country has also had an enviable economic growth with its rating as the second largest economic state in the world. It, therefore, had to maintain this state by not letting the economic crisis bury it. The aforementioned factors led to China’s current situation of high debt levels (Zhao & Chengxin, 2011). By avoiding shadow prices that its banks have adopted to justify the excess lending to the public sector, some of which are not credit worthy, will help curb the excess debt problem. If China can reduce on its approach of incurring more and more investments, like the 2009 construction stimulus that was dubious, then it can improve its economy (Li, 2012). The consumption- based approach, therefore, is a recommendable approach. Apparently, China is at an economic position in which it must reduce its debt and borrowing level. If China maintains its current growth rates, then more and more debt has to finance its economy. In order for China to produce at the same capacity, debt levels must keep on rising. It is recommendable for China to reduce its excess dependence on growth through investments and to allow for the role of consumption in its economy. It is evident that consumption in the private sectors relative to the GDP is still lowest in China compared to other major economies in the world. A consumption-based economy will rebalance China and reform it in a way that its economic growth will be slower but less risky. The consumption strategy is a safer option than a China with a predestined growth model. References Bailey, W., Huang, W., & Yang, Z. (2011). Bank Loans with Chinese Characteristics: Some Evidence on Inside Debt in a State-Controlled Banking System. Journal of Financial & Quantitative Analysis, 46(6), 1795-1830. Doi:10.1017/S0022109011000433. Jadhav, A., Neelankavil, J. P., & Andrews, D. (2012). Maximum Sustainable Level of National Debt. Journal of Accounting & Finance (2158-3625), 12(2), 51-64. Kim, S., Tan, J., & Yurim, L. (2013). Comparisons of Soft Debt Financing Problems in China and Korea. Global Conference on Business & Finance Proceedings, 8(1), 449-459. Koo, B. (2012). The Global Debt Crisis and Northeast Asia. SERI Quarterly, 5(2), 14-23 Li, M. (2012). Chinas Local Government Debt Crisis. SERI Quarterly, 5(2), 32-39. Liu, X., & Wray, L. (2010). Excessive Liquidity and Bank Lending in China. International Journal of Political Economy, 39(3), 45-63. Naito, J. (2012). Comment on Fiscal Prudence and Growth Sustainability: An Analysis of Chinas Public Debts. Asian Economic Policy Review, 7(2), 223-224. doi:10.1111/j.1748-3131.2012.01236.x Sevic, A., & Jiali, L. (2013). Determinants of Corporate Bond Yield in China. Economic Themes, 51(3), 425-440. Zhang, J. (2012). Zhu Rongji Might Be Right: Understanding the Mechanism of Fast Economic Development in China. World Economy, 35(12), 1712-1732. doi:10.1111/twec.12036 Zhao, Z., & Chengxin, C. (2011). Funding Chinas Urban Infrastructure: Revenue Structure and Financing Approaches. Public Finance & Management, 11(3), 284-305. Read More