China’s Debt Termites

BEIJING – There is no better metaphor for the economic challenge facing China than the futuristic architectural masterpiece designed to house the country’s state television network, CCTV. A few months before the landmark building was to be completed in 2009, officials at the network conducted an unauthorized fireworks display, sparking a fire that consumed a smaller building in the complex, a wedge-shaped tower that Beijing’s residents had nicknamed the Termite’s Nest.

The fire delayed the completion of the CCTV headquarters until 2012. The Termite’s Nest remains unfinished and unoccupied; its structural integrity was destroyed in the fire, and it cannot be torn down for fear of undermining its bigger neighbor. The good part of the structure cannot shake off the burden of the bad.

The two buildings recall China’s increasingly two-tracked economy: a new track based on services and consumption burdened by an old, slower track made up of industries like steel and mining, which are inefficient and suffer from excess capacity. Straddling both tracks is the country’s real-estate market, which is characterized by massive overcapacity in mid-size and smaller cities and robust demand in large cities.

The problem is compounded by the Chinese leadership’s insistence on sticking with high growth targets – 7% at present – and the resulting reliance on credit to produce the requisite output. Because the credit system has been designed around implicit state guarantees, much of the financing is misallocated to the economy’s less efficient, highly indebted sectors. As a result, the foundations of China’s growth miracle are steadily being eroded by a debt overhang that shows few signs of receding.