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China pump-priming fans 'vicious cycle' debt-and-growth fears

[June 15, 2016] By Kevin Yao and Elias Glenn

BEIJING (Reuters) - China is cranking up state spending on infrastructure to support economic growth as private-sector investment falters, raising concerns that reforms to the inefficient state sector are being kicked further down the road by the resulting build-up in debt.

Policy insiders say the slowdown in private investment is particularly worrying, since Beijing's extra spending was designed to shore up investor confidence and spur private spending, not to repeat the experience of 2008-09, when a 4 trillion yuan ($610 billion) stimulus package saddled the economy with a mountain of debt.

"We are relying on infrastructure investment to support growth, but we cannot rely too much on this. We need to motivate private investors," said an influential economist at a top government think-tank.

The figures for fixed-asset investment, which slipped below 10 percent for the first time since 2000 in January-May, show a two-track economy: private investment rose only 3.9 percent, the weakest on record, while investment by state-owned enterprises (SOEs), jumped 23.3 percent.

Chinese leaders are walking a tightrope, trying to spur growth to create jobs, prevent debt defaults and factory closures, but facing pressure to push painful structural reforms and reduce overcapacity to put the world's second-largest economy on a more balanced and sustainable footing.

The government has already pledged to expand its budget deficit to 3 percent of GDP this year to help hit its growth target of 6.5-7 percent, and some analysts expect it to exceed that after government spending jumped 17.8 percent in May, up from 4.5 percent in April.

Efforts to lure private capital into infrastructure projects via public-private partnerships have had little success due to poor returns and a lack of protection for investors' interests, analysts say.

But relying on state investment could undermine Beijing's efforts to contain rising debt levels in the economy, policy insiders say. Deleveraging is among the top five tasks listed by the government for 2016 and is a long-term goal in its new five-year plan, but most economists expect debt levels to climb further.

"If we blindly boost infrastructure investment, there could be a new round of over-building and debt problems," said an economic advisor to China's parliament.

China's Finance Ministry did not respond to a request for comment.

VICIOUS CYCLE

The International Monetary Fund was the latest to voice such concerns at the weekend, saying Beijing must act quickly to tackle mounting corporate debt, which it estimates has swelled to about 145 percent of gross domestic product - with more than half of that held by SOEs, accounting for less than a quarter of economic output.

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Consumers choose vegetables at a supermarket in Shanghai, China, March 10, 2016. REUTERS/Aly Song/File Photo

A further increase in debt levels could handicap China's long-term economic growth, David Lipton, first deputy managing director of the IMF, said on Saturday.

Moody's credit rating agency also said last month that SOE debt in China was higher than in any other rated nation, which could limit growth, lower credit availability and ultimately require state support.

The reliance on state firms to bolster the economy raises questions about Beijing's commitment to overhauling the inefficient state sector and opening up more lucrative industries to private investors.

Chinese leaders unveiled sweeping reform plans in late 2013 to let market forces play a bigger role in the economy, and pledged to achieve results by 2020, but analysts see little progress in pushing through more difficult changes.

"There is no linkage between the two (government pledges and private company actions). There's a mismatch between the government and the market. I don't see it turning around," said Zhou Hao, senior Asia emerging market economist at Commerzbank.

He said the most important factor for private firms was the outlook for global demand and China's economy.

Bai Chongen, an economist at Tsinghua University and policy adviser to China's central bank, in April cautioned against relying on the subsidised state sector for growth, citing its poor returns on investment and falling productivity.

"You have this vicious cycle – from lower growth potential to stimulus, to less improvement in efficiency, to a further decline in growth potential. We are in danger of being stuck in this trap," he told an economic seminar.

(By Kevin Yao and Elias Glenn; Editing by Will Waterman)

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