US demands that China either open up to increased foreign competition or agree on hard targets for boosting imports overlook the weakness of that nation’s economy. If President Donald Trump’s team doesn’t recognize this fragility and Beijing’s wariness, it overlooks a profound unspoken worry.
Few are inclined to think of the Chinese economy as wobbly. According to official data, 2017 marked the first acceleration in real GDP growth, to 6.9 percent, since 2010. Nominal GDP growth was in double digits for the first time since 2013 and the highest reading since 2011. Retail sales are up 10 percent and credit growth is decelerating as regulators push debt from nonbank financial institutions onto banks. The headline data paint a rosy picture.
Dig beneath those numbers, however, and things look less robust. The 2017 expansion wasn’t driven by a change in the structure of industry as much as by a reversion to old drivers. Through a combination of fiat and the encouragement of flows from wealth-management products into commodity trading, regulators successfully pushed up base input prices in 2016 and 2017.
This had a spillover impact across the economy. Mining and processing of ferrous and non-ferrous metals accounted for more than 72 percent of the growth in industrial profits last year. Back out those commodity industries, which enjoyed almost triple-digit price increases, and the remainder of Chinese industry saw profits grow by only 2.8 percent.
Banks’ nonperforming-loan ratios flattened as the most indebted and risky sectors boosted profits. The jump in nominal GDP from the commodity boom put a brake on the widely watched debt-to-GDP ratio.
While the headline numbers look better, the reality is that Beijing faces many of the old problems and has less room to maneuver. Key financial metrics remain stressed or are deteriorating. Debt-to-equity ratios of heavy industrial firms, even after the boom in profits, have barely changed. The People’s Bank of China lowered reserve ratios to allow banks to repay money they borrowed from the central bank. With the ratio of new loans to new deposits now consistently above 100 percent, and reserves to assets continuing to decline, banks are showing signs of stress as nonperforming loans, or NPLs, have ticked back up.
Beijing may want to portray confidence, but it’s well aware of this fundamental fragility. Comments by officials and advisers indicate concern about financial stress. Opening the economy to foreign competition, either through trade or investment, would add to the pressures on Chinese firms already looking to reduce their workforces.
It’s no surprise, therefore, that the industry Beijing is most keen to prize open is finance. As Chinese analysts wonder aloud about the true level of NPLs in the system, the government wants foreigners to buy bad debts and take over smaller banks. For now, overseas banks appear to be looking but not moving in. They have learned about the risks of Chinese banking ranging from loan decisions made by government officials to taking on unknown quantities of high-risk debt.
China and the Trump administration face a balancing act. The US side seems intent on receiving verifiable concessions. Apart from inviting foreign banks to bail out Chinese institutions, Beijing has shown no interest in liberalizing the economy. Trump officials can talk about not wanting to change China’s economic structure, but the reality is that’s what they are demanding – and they’re demanding it of a weakened economy.
Much of what the Trump team is seeking has been touted domestically and internationally by China for years, but not delivered. That opens the door for an agreement under which Beijing would follow through on some of those promised reforms, such as reining in subsidies and lowering total capacity, which would increase competitiveness.
Given the seeming evolution of a deal focused on observable metrics, like Chinese imports of US goods, Washington will fail if it comes away without concessions on market access. However, another way to fail is pushing too hard for market-opening measures that present excessive risk or that Beijing cannot or will not implement.
Trump is right to confront protectionism and to push for verifiable steps in any agreement. But China’s economy is weaker than the US recognizes, and progress toward a pact will need to take account of that reality.