China faces side-effects of growth medicine

China powered through the pandemic on a mix of social tranquilizers and economic Red Bull, and now it's time to deal with the headache. The world's second-largest economy managed to grow 2.3% in 2020 thanks to tough pandemic measures, an export boom and a credit flood. But local governments' fiscal stress is acute, social frictions are rising, and the private sector is still struggling.

The military-style lockdown the People's Republic imposed is widely credited with bringing contagion under control. That allowed an early return to almost-normal, letting factories restart and churn out medical supplies to serve surging overseas demand. To keep the other parts of the engine running, local governments issued record amounts of debt to ramp up spending. The central bank was conservative on interest rates compared to Western peers, but new loans totaling nearly $3 trillion were pumped out, a near 20% jump from 2019.

However, infrastructure spending barely grew, suggesting a scarcity of promising projects – much of the trillions of yuan raised in bond markets probably went to roll over loans. With debt rising and revenue shrinking, plus obligations to spend more on medical services, many local governments are severely stressed, contributing to a series of startling defaults by state firms last year. Guosheng Securities estimated that 22 out of 31 regions have debt-to-income ratios over 300%. In Hubei province, where the viral epicenter of Wuhan is located, it's 643%.

Although emergency measures have revived the headline growth figure, the private consumption and investment needed to cement the recovery remain frail. While unemployment statistics looked relatively stable, many companies cut wages or stopped paying salaries. Without much in the way of handouts from Beijing, average disposable income discounting inflation grew just 2.1% in 2020, compared to 5.8% in 2019. Private fixed-asset investment grow only 1% in 2020, whereas state investment rose 5.3%. Retail sales fell 3.9% after an 8% gain in 2019.

There are more subtle issues. While many Chinese people took pride in their collective ability to contain Covid-19 while the United States floundered, a year of unprecedented economic and psychological stress has taken a toll. Media reports of suicides and violent crime are on the rise, and now more than 100 million people in northern China are locking down again. This year could be trickier than the last.

-The third paragraph of this item has been corrected to state that the number of regions with debt-to-income ratios over 300% is 22, not 25.