Evergrande and China’s energy crisis are two sides of one coin

CHINA’S DATA on economic growth is man-made, and therefore unreliable.

That’s not the opinion of a provocateur, but the reported views of the country’s own Premier. During a dinner with US Ambassador Clark Randt in 2007, Li Keqiang — then party secretary of Liaoning province and a rising star in the Communist Party — said that official data on gross domestic product was less reliable than a mix of electricity consumption, rail cargo volumes, and loan growth. Those three figures were harder to fudge to produce a politically convenient result, he said, according to a memo from the US embassy released by Wikileaks in 2010.

That assessment has proved a pretty good guide to Chinese growth for the 14 years since, with an index weighted 20% to rail freight and 40% each to electricity and lending tracking official GDP data quite closely. That’s a troubling result right now, though — because two of the key indicators are under critical pressure at exactly the same moment.

There’s obvious reasons why loan growth may be heading for a rough patch. The crisis that’s left China Evergrande Group struggling to fund its $300 billion in liabilities may well be resolved without creating a systemic crisis. Should that happen, though, the fact the company is having such trouble getting access to fresh credit from state banks in itself indicates how the headlong pace of lending is starting to trouble Beijing.

A Lehman-style shock could see an actual reduction in credit within the system, like the 4.6% annual decline experienced by US lending in the wake of that 2008 crisis. Even a reset to more normal levels of growth would be troubling for an economy where lending has grown by at least 12% a year for decades, double the rate seen in the US.

No other major emerging economy has debt levels relative to GDP comparable to China’s, and most of the developed countries with yet-higher leverage had been reducing their indebtedness for years before COVID-19 struck, whereas China has accelerated its borrowing.

The situation with energy is oddly similar. Power rationing has spread across many of China’s economic powerhouse provinces as local governments risk missing targets for reducing the emissions intensity of their economies, with smelters in Yunnan, textile plants in Zhejiang, and soybean crushers in Tianjin all reported to have halted to prevent power cuts to non-industrial users.

For years, China’s electricity consumption has grown at a rate scarcely slower than the economy itself. That model is running into problems as President Xi Jinping’s ambitions to hit an emissions peak by 2030 start to translate into policy objectives. If China was to keep growing electricity demand at 5% a year from current levels without burning more coal, it would need to be building in the region of 100 gigawatts of solar and 50 gigawatts of wind every year — but the pace of growth being targeted is closer to half that level.

Provincial officials are thus faced with irreconcilable mandates: Keep the supply of electricity flowing to juice the economy, but keep a lid on carbon emissions, even as high-level plans for the power sector aren’t promising sufficient zero-carbon power plants to stop them falling back on a glut of coal-fired capacity to keep the grid running. The record prices seen for Chinese coal futures over the past week are the sign of a system that’s struggling to cope with the contradictory requirements placed on it.

Rail freight, the last part of the Li Keqiang Index, has performed better — but if you’re thinking of it as a measure of general activity within the economy, there’s troubling signs. China’s high-speed rail network, barely conceived of at the time Li met with the US ambassador, was in part designed to free up space on the conventional tracks so that cargo could be shifted that way, rather than by road. It’s no surprise, then, that rail has held up pretty well — but freight volumes as a whole have looked weak since before COVID-19 hit, and seem stuck at the levels of about 4.3 billion metric tons a month they hit around three years ago.

That’s concerning. One striking thing about the memo that inspired the Li Keqiang Index is how little domestic policy concerns have changed in 14 years, with much of the discussion focused on the problems of corruption and how to balance growth with income inequality. The economic model that Li described, however — where officials will stop at nothing to achieve GDP targets — is drifting toward bankruptcy.

China’s growth has been fueled for decades by credit and carbon, and Beijing finally seems to be getting serious about changing that. Whether its economy can sustain such a drastic intervention remains to be seen.

BLOOMBERG OPINION