Credit Market Turmoil Prompts China to Rethink Economic Growth and Development

By HU JIANGYUN

JUNE 20， 2013 saw SHIBOR （the Shanghai Interbank Offered Rate） soar abruptly. Overnight rates jumped 578.40 points to 13.44 percent， while one-week rates rose by 292.90 points to 11.00 percent. The following day overnight rates plummeted by 495.2 points. Though the SHIBOR roller coaster ride flattened out a month later and panic over a “liquidity freeze” gradually subsided， there is still concern over a spreading credit market crisis in China.

Both domestic and world markets are worried about the potential of J une-like fluctuations to trigger a crisis. Many experts and scholars are calling it the Chinese liquidity crisis， and even compare it to the financial implosion that began with the subprime mortgage crisis in the U.S. in mid-2008. Some are even terming it a “financial war，”such is its potential to cause damage.

The J une rate was not only the highest that SHIBOR had seen for years； it was also higher than the interbank lending rates of foreign counterparts throughout the last financial crisis. LIBOR， for example， rose no higher than 6.88 percent even during the initial 2008 mortgage meltdown.

All this indicates that China has encountered a short-term liquidity stress. But what we have seen are the symptoms of domestic credit market turmoil， rather than a fully-fledged financial crisis. How do we know this？ Well， for a start， no bank or financial institution has defaulted in China； no sharp declines in the aggregate measures of either virtual or real economic indicators have been detected.

Interbank lending rates reflect the willingness of banks to lend to each other – how much they trust each other， so to speak – and are an indicator not only of the benchmark interest rate but also the maturity of a financial market. As SHIBOR soared， the vulnerabilities in the Chinese market were revealed.

After the global financial crisis broke out， the U.S. and the E.U.， at the eye of the storm， adopted expansionary monetary policies. The U.S. termed its expansion “quantitative easing” – essentially printing money – and deemed it necessary to massively increase the money supply， and market liquidity along with it. Other governments， such as J apan， followed suit. Since then the demand for money in both the real economy and among financial institutions has risen significantly.

China is no exception. Chinese actual supply of and demand for money has kept increasing， and in the short term this has led to dramatic imbalances. Statistics show that in the first 10 days of J une 2013， Chinese banking and other financial institutions loaned about one trillion yuan， most of it invested in the real estate market. However， as local governments successively tightened regulations on the housing market through 2013， honoring repayment schedules on real estate loans became more difficult for borrowers. Furthermore， growth in the real economy didnt meet expectations， leading to a higher demand for liquidity. When the central bank renounced its loose monetary policy， turmoil in the credit market ensured.

On J une 25， 2013 Lin Tao， deputy director of the Shanghai Head Office of the Peoples Bank of China， said that the central bank would closely monitor the liquidity of the banking system， and take on flexible management of liquidity. He added the bank would move to stabilize expectations and guide market lending rates. The central banks timely signals to the market defused a potential crisis.

The credit turmoil is turning out to be a test of the new governments economic policies. Commercial banks must strengthen their capital operations and management， especially in order to improve the structure of their financial assets， coordinate liquidity， and ensure profitability and security.

However， there is a fundamental issue that needs to be addressed. The theories behind Chinas model for economic development are by no means perfect. There are holes in the system； macro policies on the money market， finance， investment and consumption are inconsistent. Merely spurring consumption demand is not a sustainable model for growth. We need to sit back and take a long， hard look at Chinas economic fundamentals.

Its not too late to do this. Chinas market economy is young； it was only in 1992 at the 14th National Congress of the CPC that the “socialist market economic system” was proposed. Thats 21 years ago. Compared to the U.S.， Chinas socialist market economy has barely entered adulthood. Maturity is still a long way off. By comparison， the U.K. and U.S. market economies have more than 100 years of historical experience on which to draw.

Chinese authorities should enhance their ability to manage the economy and continue to build the theories and framework that surround it.

We need to start by examining the basics. Investment， consumption and global trade are the three main drivers of economic development and growth， not only in China， but also globally. China has enjoyed the benefits of economic globalization as well as the burdens of factors like rising labor costs and environmental degradation. The dramatic changes in the global economic landscape over the last 10 years have accelerated Chinas economic transformation.

After the outbreak of the international financial crisis， Chinas export market shrank and we couldnt count on external demand to boost our economy. Investment and internal consumption became more important than ever.

Many experts and scholars have argued， however， that investment in China remains inefficient. It is by no means ideal to rely on large quantities of investment to realize growth. The argument thus goes that China should turn to consumption as the key driver for growth.

In theory， the consumption-driven growth model is fine. But in practice， it is not entirely suited to China， at least at the present time. The reason？ Chinas social security system remains a work in progress and other “cultural” factors inhibit the development of a consumption-driven society.

Chinese culture – and indeed the need to save for a “rainy day” given the lackluster state of social security – means currency deposits and wealth accumulation are important in the country. The“saving culture，” also prevalent in other East Asian societies， is the accumulation of thousands of years of history. While consumption “in advance” and on credit has become more widespread in recent years， only if social security is improved to cover all urban and rural areas will the countrys suspicious attitude towards high consumption change.

When people continue to run up debts just to pay for education， health care and insurance， we cant say our market economy has reached maturity. When people still hesitate to spend money， its ill advised to base an economic growth model on expanding consumption.

Currently， China is in a key phase of economic restructuring. There is much to do， including honing growth theories， improving macroeconomic management， and continuing to guide market expectations through information transparency. We should conduct investigations to ensure the economy is performing as it should. The minimum requirement is stable growth and employment security， while the upper limit demands preventing inflation， credit turmoil and overheating.

According to classical modeling， the Chinese economy of the future will no doubt give full play to the roles of capital， labor and technology. Supply structures will improve. All this isnt a foregone conclusion， however； efforts must still be made to strengthen social security， cash in on the reform dividend， improve peoples livelihood， promote investment， consumption and external demand， and insure stability and sustainability of growth.