A Chinese Tale
As the world struggles to escape from the clutches of the global recession many have placed their hopes on the same country which not too long ago was viewed with a high degree of scepticism and suspicion. In the year of the Ox China has gone from would-be villain to would-be saviour – testament to the fickleness of the foreign investment community. It’s hard however to dispute the economic importance of a country which makes up close to 20% of the globe’s population with its 1.33bn citizens.
China is by no means a wealthy country; its per capita GDP for 2008 was $5 962 compared with the US’ $46 716 (CIA Factbook, 2008). The country’s wealth is however unevenly distributed with the majority of the population still living in rural regions. The astonishing thing about China, and many other Asian countries, is the rate at which the economy is growing. China’s average growth rate between 1980 and 2008 has been a startling 10% (Guo & N’Diaye, 2009). Together with India and Indonesia, China was one of the few countries which continued to experience economic growth during the recent global recession.
There were a couple of reasons for China’s rapid recovery. Firstly, much of the downturn initially seen in the Chinese economy was a result of government’s initiatives to cool down the economy to prevent it from burning out. This they did back in 2007 by throttling back on credit destined for the housing and building sectors. This tightening, together with decreased domestic spending as a result of higher inflation (and tighter monetary policy to counter this inflation) actually saw the Chinese economy falling off long before the global economic crisis hit. When the crisis did eventually hit, part of the response to it was a reversal of the credit throttling as well as a massive injection of further liquidity in order to stimulate growth. Secondly, the sheer extent of China’s stimulus was unparalleled, totalling nearly $600bn or 14% of GDP. The effectiveness of the stimulus was accompanied by a loosening of bank lending requirements. In the West, the increased liquidity borne out of the stimulus struggled to filter through to its intended recipients, as banks continued to remain frozen in order to de-leverage their own balance sheets. In China when the government says lend, banks lend! Thirdly, China was in a much better financial condition when the recession hit . The government had a lot more reserves to fund the stimulus. Lower household debt levels meant that the average Li would be more inclined to spend than average Joe who had, in all likelihood, already over-extended himself. Lastly, the Chinese manufacturing sector has a high exposure to cyclical goods, which has the effect of making both upward and downward swings in the country’s business cycle more pronounced.
China's GDP rose 8.9% in Q3 2009, up from 7.9% in Q2 2009. The IMF, in their most recent World Economic Outlook, has forecasted that China will grow by a respectable 7.5% y/y this year. When one contrasts this with their prediction that the “Advanced Economies” will shrink by 3.8% y/y over the same period, the significance of the Chinese story becomes more apparent (IMF, 2009).
Western critics seem to be less than impressed by the Chinese tale, with some going as far as to claim that China and its Asian siblings have fiddled their GDP figures. Even if there is some merit to these allegations the counter argument would be that the Purchasing Managers Index (which is an accepted indicator of manufacturing activity) demonstrates that manufacturing production is underpinning the growth figures. Chinese PMI rose to 54.3 in September from 54.0 in August. But even these figures have come under recent scrutiny with sceptics arguing that their spurious improvement stems from a replenishment in inventory levels without any real increase in demand. This argument is not altogether unrealistic, when one considers that a large proportion of this demand resides in the “Advanced Economies” which still haven’t seen a significant improvement in consumption levels since the onset of the current recession. During 2008, the US and the EU purchased approximately 19% and 21% of China’s exports respectively (Ministry of Commerce People’s Republic of China, 2009).
The main contributors to China’s growth have been exports and investment (mainly in manufacturing capacity). According to the IMF, in the seven years till the end of 2008 net exports and investment have contributed 60% to the country’s growth. Exports are now estimated at contributing between 30% and 33% to GDP (Economist, 2009 & IMF, 2009). China’s investment rate currently hovers at around 40% of GDP – one of the highest in the world. It’s clear that China’s current growth is to a large degree being “enhanced” by government’s massive investment spending. If Chinese growth is going to be sustained over the long term, domestic spending will have to take over where government spending has left off. This will only be possible once the Chinese government releases its control over the currency. Currently China and many other Asian countries keep their currencies artificially weak in order to make their exports cheaper. They do this by purchasing foreign currency, and in so doing, build up massive foreign reserves. This is great news for the country’s exporters but not so great for the local consumer who now needs to contend with less purchasing power. It’s estimated that between 2004 and 2007 the Chinese government spent a massive $700bn on purchasing dollars or approximately 15% of GDP (Makin, 2007). During Q2 2009, China’s foreign reserves increased by 9.1% climbing $178bn to $2.13tr at quarter end and continued to grow reaching $2.273tr at the end of September 2009 (Bloomberg, 2009). This increased domestic liquidity obviously has inflationary side effects.
Inflation has not recently reared its ugly head, but another concern is equally worrying. This relates to the amount of liquidity which has been and continues to be injected into the credit markets. Chinese commercial banks loaned out a massive $1.1tr during Q1 2009. A large portion of this liquidity has found its way into the equities and property market. The ease of accessing capital, together with the limited investment options available to Chinese citizens, has resulted in increased stock market and real estate speculation (the Chinese government enforces certain capital outflow restrictions on its citizens). This speculation has caused asset prices to inflate, and could potentially lead to asset bubbles. Since Last November’s trough until this year’s high at the beginning of August, the Shanghai Composite index has increased by 103.4% (INET Bridge). Subsequently, the market has shown an equally dramatic correction, falling by 23% from its highs in August as investors became concerned that the government might start tightening monetary and credit policy. However despite more scrutiny of loans to curb the flow of money into the stock and property markets, the Chinese government has stated that it remains committed to the current policy until the global economy shows signs of stabilization. The real estate sector is somewhat trickier to balance, since the government is keen on encouraging home ownership in order to boost internal consumption as new home owners furnish their homes. Transaction volumes of property in China were up 60% during H1 2009. Chinese home sales increased 70% by value in the year to end July 2009.
Maintaining stability as well as breakneck economic growth will be difficult, and the Chinese authorities only need to look to the West to see the effects of financial imprudence. Chinese growth does however have a strong foundation as more and more formerly rural Chinese make their way into the cities. It is estimated that some 300 million rural Chinese (the equivalent of the entire US population) will migrate into the cities over the next 15 to 20 years. Currently, about 45% of the Chinese population occupy the cities (China Daily, 2009). This urbanization will no doubt lead to an increased standard of living for many which will in turn increase the demand for goods and services and boost domestic consumption levels. The massive growth in the middle class over the next two decades brought about by mass urbanization will also present the rest of the world with massive investment opportunities and will go some way to changing the power relation between East and West as China morphs from the world’s factory into the world’s market place.
References
Guo K and N’Diaye P, 2009, “Is China’s export orientated growth sustainable?”, International Monetary Fund
The International Monetary Fund, 2009 “World Economic Outlook”, International Monetary Fund
Chesters J, 2008, “The bird’s nest”, Tri-linear
Makin J H, 2007, “The role of currency in the US – China relationship”, American Enterprise Institute
Asian Development Bank, 2009, “Key Indicators for Asia and the Pacific 40th Edition”, ADB
Darmalingham S and van Dyk D, 2009. “Hoping for the best”, Standard Bank
Economist, 2009, “An astonishing rebound”
Economist, 2009, “On the rebound”
Economist, 2009, “A fine balancing act”
Trevisani J, 2009, “Has China’s stimulus been successful?”, Seeking Alpha
http://seekingalpha.com/article/159304-has-china-s-stimulus-been-successful
Jing F, 2009, “China’s cities to receive massive influx”, China Daily
http://www.chinadaily.com.cn/bizchina/2009-08/27/content_8622023.htm
Yongding Y, 2009, “China’s Yu Yongding Calls for Slower Sales of Yuan”, Bloomberg http://www.bloomberg.com/apps/news?pid=20601080&sid=aR242y98WzNY
Jun L and Zhao Y, 2009, “China Construction Bank Sees Asset Bubbles Due to Excess Cash”, Bloomberg http://www.bloomberg.com/apps/news?pid=20602082&sid=a52qvlURcU.0
