by Joe Cash

BEIJING (Reuters) – Chinese President Xi Jinping’s reform ambitions a decade ago were bold, calling for a transition to a Western-style market economy, focused on services and consumption, by 2020.

This 60-point program was supposed to correct an obsolete growth model better suited to less developed countries, but most of these reforms have come to nothing, leaving the economy largely dependent on its historical growth model which does not only increased China’s massive indebtedness and overcapacity in its industrial sector.

The failure to restructure the world’s second-largest economy has raised critical questions about the country’s future.

While many analysts believe that a slow drift towards Japanese-style stagnation is the most likely outcome, the prospect of a more serious crisis cannot be ruled out.

“Things always slowly break down until they suddenly break,” said William Hurst, professor of sinology at the University of Cambridge.

“In the short term, the risk of a larger financial crisis or economic crisis is significant and would entail very high social and political costs for the Chinese government. Accounts”.

China emerged from the Maoist planned economy in the 1980s with a still predominantly rural society in dire need of factories and infrastructure.

According to economists, when the global financial crisis hit in 2008-2009, it had already met most of its investment needs, given its level of development.

Since then, the economy has quadrupled in nominal terms, while overall debt has increased ninefold. To maintain growth at a high level, China doubled its investments in infrastructure and real estate in the 2010s, to the detriment of household consumption.

This has kept consumer demand lower than in most other countries and has concentrated job creation in the construction and industrial sectors, increasingly unattractive careers for young graduates. of the University.

This economic focus has also inflated the importance of the real estate sector, which now accounts for a quarter of economic activity, and made local governments so dependent on debt that many are now struggling to refinance themselves.

The pandemic, demographic slowdown and geopolitical tensions have exacerbated all these problems, to the point that the economy has struggled to recover this year, despite the reopening of China.

“We are at a time when we are seeing structural changes, but we should have seen them coming,” said Max Zenglein, chief economist at MERICS, an institute for China studies.

“We are just beginning to face reality. We are in uncharted territory.”

The end of China’s economic boom is likely to hurt commodity exporters and lead to disinflation around the world. Domestically, it could threaten the living standards of millions of unemployed graduates and large numbers of people whose wealth is tied to real estate, posing risks to social stability.

CRISIS AGAINST STAGNATION

Short-term solutions aside, which would only perpetuate debt-fueled investment, economists are considering three options for China.

The first is a quick and painful crisis that would wipe out debt, limit excess industrial capacity and deflate the housing bubble.

Another option is a decades-long process in which China will gradually reduce these excesses at the expense of growth.

The third is to shift to a consumption-driven model, with structural reforms that will cause short-term pain, but help the Chinese economy bounce back faster and stronger.

A crisis could arise if the huge real estate market collapses out of control, dragging the financial sector down with it.

The other sensitive point is the debt of local authorities, estimated by the International Monetary Fund (IMF) at 8.340 billion euros. In July, China promised to come up with a “package of measures” to address local government debt risks, without giving details.

Logan Wright, a partner at Rhodium Group, believes Beijing needs to decide how much of that debt to save, because the amount is too large for full repayment guarantees to be announced – when the market currently views such guarantees as implied.

“A crisis will occur in China when the credibility of the government wavers,” he added.

“When funding is suddenly halted for the remaining investments that appear to be subject to market risk, Chinese financial markets will experience a moment of considerable uncertainty.”

But given state control over many developers and banks, and a tight capital account that limits outflows of assets abroad, this is an unlikely scenario, according to experts. many economists.

Alicia Garcia Herrero, chief economist for Asia-Pacific at Natixis, expects there will be plenty of buyers if Beijing consolidates debt, given limited investment alternatives.

“I’m more in the slow growth camp,” she said. “The more debt that accumulates for projects that are not productive, the lower the return on assets, especially public investment, which means China cannot grow out of it.”

Avoiding a crisis by stifling growth, however, carries risks to stability, with youth unemployment hitting 21%, while around 70% of household wealth is invested in real estate.

“One of China’s greatest achievements, building a strong middle class, is also becoming its greatest vulnerability,” said MERICS’ Max Zenglein.

“Young people risk being the first generation after the reform (of the economy) whose economic well-being risks stagnating. If the message sent by the government is to tighten their belts and roll up their sleeves, it might be hard to swallow.”

FINALLY REFORMS?

The third path, actively shifting to a new model, is seen as highly unlikely, given what happened to Xi Jinping’s 60-point program.

Analysts say those plans have barely been mentioned since 2015, when a capital outflow scare sent stocks and the yuan plunging and sparked government aversion to potentially disruptive reforms.

Since then, China has backtracked on liberalizing financial markets, while plans to control state-owned enterprises and introduce universal social protection have never really materialized.

“Now is the time for China to change direction to a new model, and I think there is appetite for that,” said William Hurst.

“But at the same time, the short-term political and social risks, in particular that of causing an economic crisis, are the main concern.”

(Additional report Liangping Gao, Kevin Yao, graphs Kripa Jayaram, Corentin Chapron, edited by Blandine Hénault)

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