Drop in foreign trade gives China bargaining power

In the mountain of data that the China Customs department routinely puts out, one nugget stands out. The country's reliance on foreign trade dropped to 50.1 per cent in 2011.

This dip has tremendous implications for the future. For one, it indicates China is transferring to a more domestic-oriented growth mode. And more importantly, the economy has enough room to cut its reliance on foreign trade, giving it more bargaining power in the Eurozone bailout tango.

The only blip on this horizon is China's own mounting local government debts.

Foreign direct investment dropped for the third consecutive month in January with investment from 27 European Union nations shrinking 42.5 per cent year-on-year.

But will this European retreat weigh heavy on China, which has remained the most attractive FDI destination for nearly two decades? Not necessarily, if China adjusts to shrinking European demand, and turns the crisis into an opportunity.

Role reversal

Indeed, the roles have reversed with a vengeance. A raging Eurozone sovereign debt crisis needs hundreds of billions of euros worth of asset and bond sales to solve it.

European banks will probably offload €3-€5 trillion (Dh14.5-Dh24 trillion) of assets to meet tight new capital rules, and the United States has a $1 trillion (Dh3.67 trillion) fiscal deficit to close.

China has a ready purse — by some estimates $560 billion — which it can spend on overseas investment in the next five years. But as Chinese leaders never tire of asserting, they wish to put the money where infrastructure and real industrial projects are.

In fact, China Investment Corp, the nation's sovereign wealth fund, made an audacious move when they bought a minority stake in the London water supplier Thames Water Utilities. The CIC has made it clear that European government bonds are not the best purchases for long-term investors like them.

Most of the $560 billion could reasonably be expected to find its way into real assets in the economies where China has a steady income from trade. This, analysts say, would achieve two goals: balancing capital flows and reducing exposure to the paper assets from the US and Europe which the over-cautious planners are becoming cagey about.

China may seem to have the upper hand in its external negotiations as of now, but closer to home, its banks are gathering forces to ward off a debt crisis. While the US and Europe took on massive debt loads to override the 2008 meltdown, China too injected massive funds into its economy, probably taking on much more debt than it could chew.

Part of China's response to the crisis was a huge $1.7 trillion in loans from state-owned banks to provincial and city governments. These local governments used the loans to provide economic stimulus through infrastructure projects and real estate over-construction. The loans are due for repayment in the next few years, and the local governments and their construction partners are said to be in no condition to repay them.

Wave of defaults

By the end of 2010, total local government debt stood at 10.7 trillion yuan (Dh6.2 trillion). About 4.46 trillion yuan is scheduled for repayment this year. It is not clear how much local government debt might be rolled over. Foreign banks estimate that about 20 to 30 per cent of the total local government debt is unlikely to be repaid.

To avoid a wave of defaults, China's central government has instructed the banks, which would suffer the losses from defaults, to begin a major programme of rolling existing loans over into new ones.

The China Banking Regulatory Commission has ordered banks to re-assess their exposure to local government borrowing by the end of March, allowing a one-time rollover of ‘problem loans' and restricting any maturity extensions granted to a maximum of five years.

But is China right in kicking its debt crisis down the road? Brushing debt under the carpet will only blow up the scale of the problem, snatching away the slight gains it may have made in convincing the world that it is a more efficient problem solver.