At first, they took the form of quiet expressions of concern, but in recent weeks warnings about the state of China’s finances and its implications for the global economy have become a rising drumbeat.
A complex of interacting factors is involved: the slowing Chinese economy, and the problems that poses for basic manufacturing industry, especially steel; the prospect of a collapse of the real estate and development boom; and the possibility that financial arrangements involving international banks and financial institutions may soon begin to unravel because of a fall in the value of the Chinese currency.
Following the 2008 financial crisis and its impact on the Chinese economy, when more than 23 million jobs were lost in just a few months, the government initiated a massive stimulus program, including a spending package of $US500 billion—the largest in the world.
The program’s most significant feature was a directive to state-owned banks to open the credit spigots—to businesses, financial institutions and local government authorities—to finance investment in industrial capacity, real estate development and infrastructure projects.
China experienced an expansion of credit unprecedented in world economic history—by an estimated $15 trillion in the past five years. This is equivalent to the size of the entire US banking system.
Credit growth has been running at twice the rate of gross domestic product (GDP) growth. By the last quarter of 2013, credit, or “social financing” as Chinese authorities describe it, had reached 200 percent of GDP, up from 125 percent before the eruption of the global financial crisis.
Now the slowdown in the Chinese economy—this year’s official growth target is “about 7.5 percent,” compared to previous growth rates of 10 percent—is hitting all sections of manufacturing industry, particularly steel.
During the first two months of this year, members of China’s Iron and Steel Association made a collective loss of $490 million. As a result, the first quarter is likely to be “the worst performing quarter in the new century,” according to the organisation’s deputy director, Liu Zhenjiang.
Last year, the steel industry as a whole barely managed to stay profitable, recording a profit margin on sales of just 0.48 percent. The industry has become increasingly dependent on credit, with the seven largest mills owing a total of $226 billion, an amount larger than the market capitalisation of the global mining giant BHP Billiton.
Macquarie Commodities Research has reported that, according to a survey of the industry taken in mid-March, medium and small mills were all suffering a contraction in orders compared to the corresponding period last year and profits had declined to historic lows.
The month of March usually sees a rise in orders following the Chinese New Year holidays but this year there has been increasing gloom.
Speaking to the Financial Times, Colin Hamilton, an analyst at Macquarie Capital (Europe), said debt defaults in the steel industry were a distinct likelihood, because the Chinese government indicated that it is prepared to see some companies go under, due to the overcapacity in the sector.