There is a growing awareness among China's political leaders that a rebalancing of the country's economy is needed if the ongoing misallocation of capital into unviable investments is to cease.
While an adjustment of investment spending will lead to a more sustainable growth of the Chinese economy in the long term, it will hit economies that are heavily dependent on commodity exports, including the Australian economy, Beijing University Graduate School of Management professor Michael Pettis said yesterday.
"By definition, rebalancing must mean significant contraction in investments and if there is a significant contraction in investments then Chinese non-food commodities imports are going to drop dramatically," Pettis, the Washington think-tank Carnegie Endowment for International Peace senior associate, said.
"My expectation is that.. China begins the adjustment process, I hope, in 2013, 2014, because the longer they put it off, the more likely we will end up with a debt problem.
"Once they begin the adjustment, I expect the global demand for non-food commodities to drop significantly. And unfortunately I think that will affect certain economies, like Brazil, like Australia and others."
Speaking at the CFA Institute's Australia Investment Conference 2011, Pettis argued that there has been a lot of misallocation of capital to investment projects that are not commercially viable, including infrastructure projects.
"[They] are building infrastructure on top of infrastructure. There are 45 new airports in the making," he said.
Pettis said a likely catalyst for a rebalancing of the economy was a change in leadership in the Chinese Communist Party next year, when the next generation of leaders will start to assume responsibility.
"There is a great hope among many of us that when the new leadership comes in 2012, they will begin steps to rebalance," he said.
"There is even a growing sense among economists in Beijing that growth rates are going to slow significantly."
"We now suddenly hear talk about 5,6, 7 per cent growth rates (of gross domestic product (GDP))."
"The problem is that if they are overly optimistic. For China to rebalance, I think growth rates in the next decade are going to average around 3 per cent," he said.
Pettis argued China will not be able to hold off on rebalancing the economy for long, because it will exacerbate the problem.
"The longer it postpones adjustment, the more misallocation there is," he said. "And the consequence of misallocation is an increase in debt."
"If there is a lot of this unserviceable debt the only way we can serve it is by transferring directly or indirectly from household savings," he said.
"The more debt you have, the more important those transfers from the household sectors are in order to keep the financial system viable and the more important those transfers the harder it is for households incomes to rise quickly enough to cause a surge in consumption."
"So they are caught in a trap and there is no easy way out," Pettis said.
