China - Economy "Mini-Stimulus" Is Maxi Mistake - by Gordon G. Chang

On Wednesday, Premier Li Keqiang made what has been described as China’s first stimulus announcement of 2014.  The “mini-stimulus” plan will extend large tax breaks to small businesses, build social housing to replace shanty villages, and accelerate the building of rail lines.

The announcement followed a major policy address Li made on March 26.  “We have gathered experience from successfully battling the economic downturn last year and we have policies in store to counter economic volatility for this year,” he said then.  “We will launch relevant and forceful measures according to what we have planned in our government work report.”

Analysts, by and large, were not impressed with Li’s words in late March.  As Du Changchun of Northeast Securities in Shanghai said to Reuters at the time, “The market reaction really hasn’t been that great as these comments have been said many times before.”

What Li needed to do last week was to show that he had the right policies to stabilize an economy that is deteriorating quickly.  Observers expect this year’s first quarter to be the weakest in five years.

So how did the markets react to Wednesday’s mini-stimulus?  On Thursday, the Shanghai Composite fell, but it recovered most of its losses Friday.  Li, therefore, largely failed to bolster sentiment.  And that’s what his announcement last week was all about.  As Julian Evans-Pritchard of Capital Economics in Singapore noted, “They want to make it clear they have the ability to step in if necessary.”

At this point, Li and his technocrats look like they do not have that ability.  The principal problem is that they are still struggling with the ill effects of Wen Jiabao’s stimulus plan, announced in November 2008, to spend 4 trillion yuan.  The legacy of that effort, which when combined with bank lending was one of the biggest fiscal spending programs in the last 15 years, is a country choking on debt.  China’s total debt-to-GDP ratio is now somewhere north of 300% when GDP is properly adjusted—deflated—to account for price changes.

The symptoms of China’s debt accumulation are alarming.  There have been, within just the space of a month, the first domestic corporate bond default in the history of the People’s Republic, the first domestic junk bond default, and two bank runs.

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