The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
5/5/2020 Remarks by Under Secretary Nathan Sheets at the China Finance 40 Forum U.S. DEPARTMENT OF THE TREASURY Press Center Remarks by Under Secretary Nathan Sheets at the China Finance 40 Forum 12/5/2016 BEIJING - Thank you for that introduction. Let me also thank the China Finance 40 for hosting this event. I will speak today on two topics that are closely related: first, China’s economic rebalancing, which is a familiar theme in discussions of China’s role in the global economy; and second, rising debt levels in China’s corporate sector, a phenomenon that is increasingly a focus for China’s policymakers as well as for global markets. China’s total debt has risen to 220 percent of GDP, according to the IMF, having increased by roughly one-third in the past five years alone. Debt of China’s non-financial corporate sector, at about 145 percent of GDP, is among the highest for major economies. My central point today is that rising corporate leverage reflects the still incomplete nature of China’s economic rebalancing, and underscores the urgency of China accelerating its market-oriented reforms. Rebalancing and deleveraging are in fact mutually reinforcing efforts, and both are necessary to help ensure China’s sustainable growth into the future. When I refer to rebalancing, I am highlighting five inter-related and necessary transitions that are underway in China's economy: · · · · · First, the transition from a growth model largely driven by external demand to one reliant on domestic demand; Second, within domestic demand, a transition from reliance on fixed asset investment toward household consumption; Third, a transition from an economy driven by manufacturing to one driven by services; Fourth, a transition from growth that is energy- and resource-intensive toward more environmentally-friendly growth; And finally, the continued transition from a state-dominated economy to a true level-playing field for private sector participants both domestic and foreign. China’s rebalancing from exports to domestic demand has been notable. Whereas net exports added well over one percentage point to China’s GDP growth in the years leading up to the Global Financial Crisis, that pattern reversed in a big way from 2008 through 2011. Since then, net exports have made little contribution to growth on average. At the same time, China’s current account surplus has narrowed significantly, from a record 10 percent of GDP just ahead of the global financial crisis to roughly 2 to 3 percent of GDP at present. The majority of that adjustment came in the form of lower goods surpluses, with some recent widening in the services deficit as well. It is worth noting the role of RMB appreciation in narrowing what had been excessive Chinese current account surpluses, with China’s real effective exchange rate having appreciated over 40 percent since 2005. While the reduced reliance on exports is encouraging, domestic demand remains overly dependent on fixed asset investment. Investment is much higher in China as a share of GDP than in other major economies; China is also the only economy where investment accounted for a larger share of GDP than private consumption. The good news is that in recent years, private consumption has been growing more quickly than overall GDP, but the prevailing imbalance means that it will take many years of consumption-led growth to achieve a more balanced economy. Notably, if China’s investment slows without consumption growth rising sufficiently to take its place, China risks a marked weakening in its growth rates, with external surpluses again rising as domestic imbalances unwind. This has in fact been the case with other Asian economies, which have typically seen their current accounts widen as investment rates have declined from their peaks. The crucial difference, however, is that China is now the second largest economy in the world, leaving little scope for global demand—which already faces a number of headwinds in the medium term—to accommodate a large and sudden rise in China’s current account balance. Reducing the over-reliance on fixed investment is particularly important when we consider that it has been driving the rise in corporate debt. Most fixed investment is funded through bank credit; however, each unit of new investment has become less efficient in producing additional economic output. As a result, a greater amount of both investment and credit have been necessary to sustain China’s high rates of GDP growth. Turning to production—the third rebalancing—China’s services sector has overtaken manufacturing in terms of GDP and is vastly outpacing the industrial and agricultural sectors in creating new jobs. This has helped support China’s labor market even as heavy industry has significantly declined and overall growth has slowed. Even so, there is room for substantial further expansion of China’s services sector, which remains smaller as a share of GDP than other economies of China’s income level. Although the decline in heavy industry poses challenges, particularly in certain regions in China, it has the positive aspect of reducing China’s reliance on energy-intensive and highly polluting sectors, the fourth rebalancing. China’s energy intensity, or the amount of energy required to produce a unit of GDP, has declined significantly over the past years, but is still higher than that of the United States and major emerging markets. A truly level playing field for the private sector—the fifth and final transition—is essential for China to improve its allocation of credit and other resources, and to sustain its economic dynamism. SOEs tend to be less profitable and more highly leveraged than their private peers. While China has shifted away from a majority state-owned economy, state-controlled enterprises still account for nearly 40 percent of the economy’s total assets. Urban SOEs account for more than 30 percent of annual fixed asset investment and nearly 20 percent of urban employment. Remarkably, SOEs still receive nearly half of total corporate credit, while generating only 21 percent of revenues and 18 percent of profits. This fact speaks to policies that inefficiently encourage lending to SOEs at the expense of private sector firms. The IMF estimates that SOEs benefit from indirect subsidies on the scale of 3 percent of GDP, of which about half is subsidized support from the financial sector. According to S&P, the median leverage of SOEs is twice that of private firms. Drawing on the discussion above, I see four critical interlinkages between China’s rising corporate leverage and the need for economic rebalancing: · · · · First, the reliance on investment-led growth, much of it funded through bank loans, is fueling a continued build-up of debt in the corporate sector. Second, SOEs, which retain preferential access to the financial sector, receive a disproportionate amount of credit and are more highly leveraged despite being less efficient and profitable than private firms. Third, highly leveraged SOEs are concentrated in energy-intensive and polluting manufacturing industries such as steel, which suffer from excess capacity. Fourth, some evidence suggests that a significant and rising share of new credit is going to roll over loans to loss-making firms in these sectors—so-called “zombie companies.” This imposes an unsustainable drag on the financial system and impedes the flow of capital to high-growth sectors. While high and rising leverage underscores the need for prompt action, I believe that China has the capacity to address this challenge. Government and household debt levels are manageable, the banking sector has sizable buffers, and overall growth remains stable and relatively strong. However, the authorities must implement announced reforms. They would be well served to vigorously address the level of indebtedness in the economy and chart a course toward less credit-intensive growth. Let me discuss some specific priorities. https://www.treasury.gov/press-center/press-releases/Pages/jl0671.aspx 1/2 5/5/2020 Remarks by Under Secretary Nathan Sheets at the China Finance 40 Forum First and foremost, China should accelerate its domestic rebalancing efforts. With an economy led by services, household consumption, and the private sector, China would be able to grow in a less capital- and credit-intensive manner—with the added benefits of using less energy and reducing pollution. This begins with intensifying efforts to make household consumption the main engine of the economy. The authorities have shown some willingness to accept a larger fiscal deficit this year to support domestic demand, but further fiscal measures that target household consumption are needed. These include strengthening the social safety net, extending social benefits to more migrant workers, and covering reemployment costs for laid-off workers in excess-capacity industries. Next, to further expand the role of services in China’s economy, it is important to remove the pervasive barriers that restrict private firms, both domestic and foreign, from participating in China’s services sector. A successful conclusion of a high standard bilateral investment treaty or “BIT”, currently under negotiation, would represent a major step toward reducing the state’s dominant role in services. Foreign investment can be an important catalyst for services, promoting more competition and ultimately greater productivity, both of which are essential to vibrant economic performance. Domestic rebalancing may entail slower growth in the short term, particularly as structural reforms are put into place, but will contribute to more sustainable growth in the longer term. This highlights a related point: The authorities would be well-advised to phase out GDP growth targets. The existing targets perpetuate a “growth at all costs” mentality, encouraging bank loans and local government expenditure on unproductive investments. At the same time, by making full use of their macroeconomic toolkit, the authorities can support overall economic growth through the deleveraging process. In China’s case, fiscal policy can play an important role, in two respects: first, by expanding targeted assistance, such as the 100 billion RMB fund established for workers laid off from excess-capacity industries; and second, through fiscal stimulus that offsets the contractionary effects of deleveraging as firms reduce their debt burdens. Adopting policies to remove distortions, particularly in the state sector, will be critical. Given their disproportionate share of credit, reforming state-owned enterprises is also a necessary —indeed, an indispensable—feature of China’s deleveraging and corporate restructuring. The elements of such reform must include removing the state guarantees and financial sector support that SOEs receive at the expense of private sector firms. In recent months, we have seen a number of SOEs default on bonds. This development, if properly managed, sends an important signal to investors and creditors that they must evaluate firms on the basis of fundamentals, rather than on expectations of state support. In this context, the authorities’ intention to improve bankruptcy laws and take other steps to allow for the orderly exit of “zombie companies” from the market is important. This initiative is central to resolving not only high leverage but also excess capacity in sectors such as steel and aluminum, an issue that is important to the United States and the global economy. At their bilateral meeting in Hangzhou, on the margins of the G-20 Summit, President Obama and President Xi committed to work cooperatively in this area, with the United States sharing technical expertise on the role bankruptcy plays in our corporate restructurings. And at their most recent meeting in Lima, Peru, President Obama underscored the urgency of addressing excess capacity in industrial sectors, including by launching without delay the Global Forum on Steel Excess Capacity. More fundamentally, further reforms to China’s financial sector are necessary to reduce financial sector risks and driving broader economic rebalancing. Such efforts should include incentivizing banks to lend to the most productive investments, not those that have traditionally enjoyed an implicit state guarantee. As the transition from manufacturing to services proceeds, the efficiency of credit should increase as modern services and other new industries will likely require less credit to sustain their growth. Because an increasing amount of credit is extended through China’s shadow banking system, getting a firm grasp on shadow banking activity and its attendant risks is also a necessary component of addressing debt and deleveraging. Continued development of China’s capital markets will provide long-term financing to China’s corporate sector and reduce reliance on the banking system. To function effectively, capital markets must exist within a supportive ecosystem, which includes independent credit rating agencies, clear and well-established rights for shareholders and creditors, and strong corporate governance practices. As a closely related matter, further efforts to foster conditions to allow an orderly transition to a market-determined exchange rate are also central to China’s economic rebalancing. Finally, let me say a word about the importance of transparency. Being transparent about actions—particularly in the financial sector—is critical to the credibility and ultimate success of deleveraging efforts. In the United States, our robust stress tests provided a credible and transparent assessment of the weaknesses in our financial system. These stress tests have paved the way for banks to raise capital and resume credit growth. The need for such transparency also applies to China’s economic data. It is hard to judge China’s progress toward increased household consumption when key data are only released once a year. Similarly, growth in services is admittedly difficult to measure, due to the relatively small average size of service sector firms and a tendency toward operating informally. Even so, improved data on the performance of the services sector would help shed light on China’s progress toward rebalancing. Recognizing these issues, at this year’s S&ED, China committed to publish a more comprehensive monthly indicator of growth in services, and to continue to improve its quarterly GDP expenditure data. CONCLUSION In early October, China’s State Council announced “Guidelines on Corporate Deleveraging,” the most comprehensive policy document to date to discuss how the Chinese authorities plan to address high corporate leverage. Later that month, the State Council set up an inter-ministerial joint conference to implement these guidelines. Such steps toward a comprehensive approach to debt and the banking sector are very encouraging. We must not underestimate the size of the task at hand for China, but we also should not discount the resources that China has to address these challenges. As China undertakes these efforts, enhanced data transparency and policy communication will help both domestic and international stakeholders measure China’s progress toward these goals and foster confidence in China’s reform trajectory. The United States should continue to engage constructively with China to support the reform agenda. China’s success matters tremendously for its own economy, as well as for our economy in the United States and for others around the world. Thank you. For slides that accompany the text, please click here . ### https://www.treasury.gov/press-center/press-releases/Pages/jl0671.aspx 2/2
@FedFRASER