Rudd might be right on China’s economic slowdown

In his first appearance as re-installed prime minister, Kevin Rudd dragged China front and centre into the Australian election campaign.

“The global economy is still experiencing the slowest of recoveries. The China resources boom is over … and when China represents such a large slice of Australia’s own economy, our jobs, and the opportunities for raising our living standards, the time has come for us to adjust to the new challenges,” he said in his first press conference as born-again PM.

Australia and China’s fates are ever more intertwined. It’s our largest trade partner by a country mile; $125 billion versus second-placed Japan’s $75 billion.

Rudd’s strategy in calling time on the boom was effective, a clean break from the increasingly hard to swallow “the economy is fabulous” message peddled by Julia Gillard.

But the reality had been clear for some time: China’s economy is slowing more seriously than was expected at the start of the year, and Australia’s Treasury has its forecasts on China wrong. Yesterday Reserve Bank chief Glenn Stevens backed up Rudd and held rates at their all-time low of 2.75%.

“The economy has been growing a bit below trend over the recent period … this is expected to continue in the near term as the economy adjusts to lower levels of mining investment,” Stevens said.

Last week, it became more apparent that it’s not just a slowdown China is having, but something of a mini-crisis. And they have a nasty way of getting bigger. The People’s Bank of China (PBOC) stood aside while interbank rates — the rates banks lend to each other — soared. This placed banks holding too much unserviceable debt in peril and potentially placed smaller banks in danger. It was a message that loose credit and sloppy lending won’t be tolerated.

China’s former Hu Jintao / Wen Jiabao administration’s once-lauded 4 trillion yuan stimulus (that may have been triple that if you add in state-sponsored lending) is now proving a rod for the new leadership’s back. The stimulus has created dreadful habits in its banks and a massive shadow banking system. China’s debt-to-GDP ratio has soared from 70% to 200% in five years.

The Chinese government has been saying for the past year that it wants to slow the economy. Its concerted action on the property market has had some effect, but there are still few other places apart from the banks and property for Chinese to keep their money. Unlike the central bank in Australia (and other real market economies) the PBOC is far from independent, dancing to the tune of the Communist Party’s powerful Leading Group for Financial and Economic Affairs, headed by Premier Li Keqiang.

This was a shot across the bank’s bows by its masters, a pullback on the go-go credit growth that is continuing to create non-performing loans and overcapacity in industry. Exhibit one: China’s overproducing, loss-making steel sector.

It’s the first strong sign that Li and his boss, Chinese President Xi Jinping, are serious about reform. Now there will be a deathly period of calm until the Communist Party’s third plenum in October while the new leadership tries to beat back its internal critics and finalise its first reforms.

This article continues on page 2.

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