China

China's Alibaba Economy Promises an Escape From the Country's Debt Trap


Doomsday theorists see a Chinese economy mired in debt and destined to fail. The reality is more nuanced, with new consumer and technology companies providing more bang for less debt. There’s no shortage of negative news. Tales of debt-burdened coal mines and real estate developers abound. Rising overcapacity means factory gate prices have been falling for more than two years. Nonperforming loans at the banks have been rising since the end of 2011, and—it is suspected—the reported total is only the tip of the iceberg.

The real situation is not so dire. A rapid rise in corporate borrowing in the years after the 2008 financial crisis has now started to level off. The ratio of debt to equity for companies listed on the Shanghai Composite Index peaked at 159 percent in the middle of 2012 and has now started to edge down. That’s some way short of the 234 percent level in the U.S. on the eve of the Lehman collapse.

The sector detail also reveals cause for optimism to temper the gloom. In the old, state-dominated, capital-intensive sectors of industry, the burden of debt is high and returns are low. In emerging sectors utilizing technology to focus on China’s rising consumer class, private sector businesses are showing substantially higher returns.

In shipping, overinvestment by such state-owned giants as China Cosco has made the sector a prime example of the excesses of credit and capital spending-led growth. Cosco has debt to equity of 228 percent and a return on equity barely above zero. For the sector as a whole, with many companies in the red, return on assets is negative. Traditional sectors, such as iron and steel, find themselves in the same leaky boat.

In the technology sector, by contrast, where such companies as e-commerce giant Alibaba are harnessing the power of an innovative workforce and catering to the aspirations of rising middle-class consumers, the numbers look considerably better. Chinese technology companies average debt to equity of just 32.3 percent and boast a return on assets of 12.5 percent.

The pendulum is swinging in the right direction. China’s leaders have been reluctant to mount a frontal assault on the privileges of the state-sector companies that dominate the old economy. The forced bankruptcies and mergers that occurred at the end of the 1990s have not reappeared. Even so, higher costs for credit, land, and energy are all eroding profits.

The numbers are clear. In output, profits and employment the private sector are doing better than in the state sector, and services are outperforming manufacturing. Profits at state-owned companies managed just a 2.6 percent annual increase in the first four months of 2014, whereas profits in the private sector were up 13.8 percent. In 2013, the service sector was a bigger contributor to GDP than manufacturing.

Doomsday theorists—focused on the old economy—say that with ever-increasing credit required to produce ever-decreasing growth, China is destined for an economic slump, financial crisis, or both. The promise of the new economy is that with consumer and technology-orientated businesses producing higher returns with less debt, robust growth can be sustained for a while longer.

Orlik is a Beijing-based economist for Bloomberg.

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