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Is the pessimism about the Chinese economy warranted?

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In Brief

The prospects for China’s growth in 2009 have become a very controversial issue in the context of the unfolding global financial crisis. In the World Economic Outlook Update, released by IMF on January 28, China’s growth rate in 2009 has been revised sharply downwards to 6.7 per cent from the previous estimate of 9.3 per cent released last October. By contrast, the estimates by some investment banks, such as Nomura International (HK) Limited, believe that China should be able to maintain a growth rate of 8 per cent or even higher.

We take an optimistic stance in our prediction for several reasons.


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The rapid decline in growth in the last quarter of 2008 to 6.8 per cent from 9 per cent in the previous quarter is by and large a reflection of the inventory de-stocking caused by the collapse of global commodity markets. Although the process is still ongoing, it is very likely to be over by the first half of 2009.

In fact, the purchasing manager index (PMI), the most-widely used leading indicator of business confidence, has been rising persistently over the past two months, although it remains below 50. Once this inventory adjustment ends, production could rebound sharply.

The 2009-2010 stimulus package of RMB 4 trillion should be effective in averting domestic demand contraction if combined with tax reduction measures, a switch to an expansionary monetary policy and many sequentially announced industrial promotion measures. It is expected that at least RMB 500 billion worth of project investment (part of the stimulus package, including RMB 100 billion from central government and RMB 400 billion from local governments) will be in place by the end of March 2009.

The VAT rebate for purchasing machinery and equipment and an increase in the export rebate rate is likely to have a strongly stimulating effect on investment. A reduction in the interest rate and bank reserve requirement ratio, the loosening of controls on mortgage loans, removing quota controls on lending by commercial banks (temporarily introduced in early 2008), accelerating development of credit guarantee services, and other financial promotion measures have actually led the rapid recovery of new loans in the past two months.

Bank lending grew by 21.3 per cent year-on-year in January 2009, up from 18.8 per cent in December 2008. Plans for promoting the automobile, steel, textile, equipment machinery and other industrial sectors are also likely to have a significant impact on the economic recovery.

China has a very strong fiscal position for implementing the package of stimulus measures and even for enlarging its scale if necessary. China’s fiscal revenues as a share of GDP increased from 11 per cent in 1997 to 21 per cent 2007, providing a solid base for fiscal expansion. In 2008, the ratio of fiscal deficit to GDP amounted to a mere 0.6 per cent. If export performance severely deteriorates in the coming few months, more fiscal stimulus measures are very likely to be announced.

China’s banking sector remains sound and healthy. The average ratio of non-performing loans (NPL) for all commercial banks and state-owned banks have been successfully reduced from 25 per cent in 2002 to about 6 per cent in 2008. Moreover, compared to banks in other countries, the financial losses linked to the sub-prime crisis by Chinese banks are limited. The sound banking sector will surely provide room for the possible deterioration of loan quality, which is likely to happen in the future due to the loosening controls on credit risks during the economic downturn.

The bottom line is that China’s forceful stimulus package and the related measures will strongly boost domestic demand, offsetting the significant drop in external demand and keeping the growth rate around 8 per cent or even higher.

While being confident of the economic recovery and growth in 2009, we should remain concerned about the potential risks or long-term impacts of the stimulus package and related measures.

One of the most important concerns is that the stimulus package might prolong China’s reliance on an investment-driven growth model and delay necessary structural adjustment. This risk could be minimized by giving priority to social security, education, medical care and other modern service sectors when allocating public investment.

Another concern related to the slowing process of reducing the economy’s excessive reliance on external demand by keeping renminbi exchange rate relatively stable. This is necessary for eliminating the negative external shock, and also for improving the effectiveness of fiscal expansion. But when the external shock dissipates, the government should allow the renminbi to appreciate gradually in accordance with structural adjustment needs. Finally, though a rebound of the NPL rate seems to be unavoidable, it is vitally important to keep it under control though comprehensive and effective financial regulation.

Professor Liqing Zhang is Dean of the School of Finance, Central University of Finance and Economics, Beijing.

7 responses to “Is the pessimism about the Chinese economy warranted?”

  1. Supply and demand, if foreign countries are not buying exports will keep dropping. Now with massive job losses over seas we are seeing a huge economic shift in the world. China’s weak point is it relies so much on a export driven economy. The the stimulus package only makes a few rich companies close to the government richer, it does not help the millions of poor or create long term domestic consumption. After the stimulus then what? as this is just a temporary measure that can’t last for that long. Considering the rest of the world keeps going down, and millions more are losing jobs I can’t see how demand is going to pick back up this year at all. In fact, I feel that we will see a global depression as stimulus packages around the world don’t seem to be having the desired affect. Yes, they help, but at the end of the day most people know now that we have been sending on credit for to long and the debt has caught up to us.

    Your article does not focus on an important point which is what happens to the millions that have lost jobs and the millions more that are going to lose jobs. The stimulus package only targets a few. The level of protests in China is growing fast, if this is not contained foreign investors will pull money out of China if they feel there is risk with social unrest.

    Deflation is taking hold in China, you have built up so much reserve cash and printed yuan, does that mean with loan rates increasing from the banks that you have a lot more money out there, if so the yuan devalues which lowers the buying power for the average Chinese person, the Deflation does a 180 and turns fast into inflation because commodity prices start to rise again, creating more angry poor people in China that find over the next 6 months that they can’t even afford to buy simple food products.

  2. James, ask David Dollar to read the report from the World Bank done on China’s water crisis. I think the environment issues in China are at a point where things are starting to break in China, coming at a time on the back of the economic crisis. Its a scary report on the water shortage problems of China. And the damage that has been done to water systems is nothing more than a social time bomb waiting to explode. The bad drought in the North this year 2009 is a good example. Water been pumped from all over the place just increases the loss of water in other areas. With a massive stimulus package this year I would expect many environment policies to be put on the side lines while focusing on the economy, steel and cement factories been some of the biggest polluters it just seems in China that the outlook for its future is getting worse not better. In the quest for a better life and money I find China in fact is destroying itself from the inside out.

  3. ReallyNotSure:
    The concept that China is “over reliant on exports” is weak. There is no economic logic in pushing domestic demand if purchasing power abroad is greater than at home. Deriding producers for selling to those with money is lunacy. Obviously if existing customers lose purchasing power, producers should find new customers, reduce their prices or reduce their quantity. It is not a “weak point” of China to have been selling to those who, till now, had the resources to pay. Inability to adapt to a changed environment would be, however.

    On what basis do you assert the stimulus “does not help the millions of poor”?. It includes RMB1.8 trillion investment in railways, roads, airports and power grids, 1 trillion in post earthquake reconstruction, and 370 billion in rural development and infrastructure projects. Are you suggesting Shanghai fatcats will take up shovels and rebuild Sichuan, lay rail tracks and power lines, pour concrete for dams and staff the restaurants and small businesses that service all the workers who do do all that work?

    Regarding protests: the repeal of hukou restrictions on graduates is a stroke of genius. It endears the government to the young educated class, while simultaneously increasing flexibility in the labor market without risking mass migration and increasing the incentive to study at the tertiary level, thus increasing the long term productivity of Chinese workers.

    You say “deflation is taking hold in China”. China’s inflation rate, as measured by the consumer price index was 1.0% in January. Since 1% is not less than 0% this does not constitute deflation. Even if China were in deflation (which it is not) deflation does not reduce the purchasing power of ‘average Chinese’. Deflation is a fall in prices, or equivalently, an increase in the value of money.

    You make the good point that China has many pressing environmental concerns. This is indeed true and should be addressed as part of the stimulus process, not sidelined by it.

    Professor Zhang has laid out a solid case against excess pessimism. A case that should be heard and heeded, not scorned.

  4. I see the stimulus package as a largely positive thing. Stimulating investment in this way will help expand China’s already growing middle class. Which will lay the foundation for increases domestic consumer spending in the long term. Right now it makes sense for the Chinese economy to depend on exprts as Qjing points out. But with giant economies like that of the U.S. rapidly contracting almost daily, it is wise for the Chinese to strengthen and grow their domestic consumer base in the long term.

  5. Rosa, basically I agree with you, but it wasn’t quite my point that China should ‘depend’ on exports exactly. More that any business maximising profits will target their products to consumers able to purchase them. Up to now, that has largely meant US and EU consumers (that’s where most disposable income is located). This shouldn’t be thought of as a national strategy, just the natural result of a functioning market.

    Now people almost everywhere aren’t treating their income as disposable because of uncertainty about future earnings.

    How can the Chinese ‘strengthen and grow their domestic consumer base’?
    Consumption is a function of income, which is determined by productivity and the pace of the economy (the money multiplier) and the savings rate, which is determined by the interest rate and future expectations (confidence). The pace of the economy is unfortunately very much slower than it has been due to the global crisis of confidence, which also increases the savings rate.

    The Chinese government can help reduce a few barriers to confidence such as improving insurance coverage and increasing employment. Since the private sector cannot borrow currently due to high risk aversion in financial markets, the best way to increase employment quickly is government consumption. This can be usefully targeted toward long term productivity enhancing investments.

    The idea that the government should increase domestic consumption to off-set the fall in foreign consumption is, I feel, a misunderstanding of the nature of household consumption. Governments can invest in long term productivity if private asset holders are unwilling to do so, and they can try to increase confidence, but they can’t directly increase domestic household consumption.

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