In the first of our annual year-in-review series, Yiping Huang suggests that 2012 will not be a replay of 2009, with neither a hard landing nor a sharp rebound looking likely over the coming twelve months. GDP growth, Huang says, is likely to slow from 9.1 per cent in 2011 to 8.1 per cent in 2012 — with softer external demand and weaker residential investment — and inflation is likely to ease from 5.5 per cent to 3.2 per cent, but the outlook for China remains robust. Consumption is likely to play a greater role as household expenditure continues upward, and both monetary and fiscal policy settings should be modestly expansionary.

If Huang is right, as he usually is, this outlook for the Chinese economy is good news for the region and a boost for global recovery. Shaving 1 per cent off Chinese growth through the year would leave a strong performance in China and modest adverse impact on China’s overseas partners.

The two big risks for China are deepening recession in the industrial world economy and a disorderly correction of the housing market at home. China is suffering from a range of proximate economic problems, which have prompted fears of a hard landing. There has been a rapid increase in the number of small and medium enterprises (SMEs) declaring bankruptcy. Private lending has been drying up in some areas. In the last half of 2011 house prices were on a downward trend, with potentially significant implications for investment growth and asset quality. And, with the collapse of the real estate market, local governments are inevitably in trouble. Local government investment vehicles, with total liabilities of at least 10.7 trillion yuan (US$1.7 trillion), are finding it difficult to repay loans on schedule. In addition, the recent expansion of shadow banking transactions has opened up risks for the financial system.

With this bundle of problems, why is Huang so confident China will pull through the year so strongly? He cites three main reasons for why they are unlikely to lead to a hard landing of the Chinese economy.

First, the changes under way have been deliberately induced by policy adjustment, such as macro-policy tightening and housing investment restrictions. Some changes, such as the correction of property prices, were necessary to generate healthy development in the future. Should circumstances deteriorate sharply, the government will be able to reverse the policies quickly and buttress economic growth.

Second, these problems are not developing into systemic macro risks at this stage. Despite an increasing incidence of bankruptcy, the SME sector (read the private sector) as a whole is still underwriting steady growth. The widely reported collapse of private lending activities is isolated to particular regions, confined largely to a couple of cities in Zhejiang and Inner Mongolia.

And finally, balance sheets are still quite healthy for households, banks and the government — all of which should remain resilient even if the economic situation deteriorates. Total household borrowing is below 18 per cent of GDP, less than the value of households’ annual savings. If property prices decline modestly, households will not be forced to deleverage. And given the banks’ average non-performing loan ratio is low, at 2 per cent, and the reserve requirement ratio (RRR) is 21 per cent, some deterioration of credit quality is unlikely to make the banks dysfunctional in the near future. Public debt is only 17 per cent of GDP in China. If all contingent liabilities are included, that figure could blow out to nearly 70 per cent of GDP, but the government still has room to use fiscal resources to contain domestic risks and support economic growth.

The good news for the international economy is that the structure of Chinese growth through the new year will see gradual re-balancing toward the domestic economy. That will help relieve some of the global adjustment pressures. The sluggish external economic environment will see export and import growth likely halve to 9.8 per cent and 12.8 per cent, respectively, and a fall in net exports, accounting for almost half of the 1 percentage point drop in GDP. Despite the uncertainty surrounding housing, ‘residential investment should continue to grow in 2012 — albeit at a slower pace — due to large development projects, ongoing construction and the expansion of public housing’.

Consumption, Huang argues, will in fact be the key to maintaining the strength of the Chinese economy in 2012, although the pace of its expansion may moderate. ‘In recent years’, he points out, ‘retail sales have consistently outperformed GDP. But the GDP-by-expenditure data continuously show declining consumption, due to reporting errors in household survey data, such as the under-reporting of income and household spending. Estimates combining information from both GDP by expenditure and retail sales suggest a turning point in 2007, after which consumption’s share of GDP actually picked up steadily’. This is consistent with improvements in the Chinese social welfare system and the rapid growth that has been taking place in wage income.

All this suggests a good Chinese new year is in the offing.

And a note from the editors

The East Asia Forum continued to expand its reach in 2011. We moved to a new website and twice found we had to upgrade our server throughout the year due to increased traffic. Our hits more than doubled from 2010 and weekly email subscriptions grew by 20 per cent. We also saw rapid growth in our Facebook and Twitter presence and have started a Google+ page.

Most importantly, we have had great contributions.

The great contributions from around the region are what make EAF. It is a site owned by its contributors — a regional resource produced by analysts throughout Asia and the Pacific.

Our top most-read posts in 2011 (*some from 2010 and 2009) deserve highlighting.

1. 2011 East Asia Summit: New members, challenges and opportunities, Monica Wihardja, CSIS Jakarta
2. Japan’s earthquake and its economic impact, Peter Drysdale, ANU
3. Riding the global economic crisis in Singapore, Shandre, NUS, Singapore
4. Reforming housing for the poor in the Philippines, Marife Ballesteros, PIDS
5. The Philippines: Weak institutions drag on economic performance, Josef T. Yap, PIDS
6. The RMB and Chinese exchange rate policy: some misperceptions, Yiping Huang, Peking University and ANU
7. The impact of China’s 12th Five Year Plan, Yongsheng Zhang, DRC
8. China’s response to the global financial crisis, Yu Yongding, CASS, Beijing
9. The scale of China’s economic impact, Ligang Song, ANU
10. Vietnam’s endless corruption campaign, Long S. Le, University of Houston
11. Indonesia: Blessed by strong economic growth and the curse of resources, Thee Kian Wie, LIPI, Jakarta
12. Financial crisis: Can Asia skate through again?, Barry Eichengreen, UC Berkeley
13. Here we go again: Vietnam’s spiral of credit and devaluation, David Dapice, Harvard University
14. China’s role in running the world economy, Peter Drysdale, ANU
15. China’s rising sex ratio at birth, Zhongwei Zhao, ANU, and Wei Chen, People’s University of China
16. China’s export-led growth model, Yang Yao, Peking University

We value your feedback and wish all our readers and contributors the very best for 2012.

Peter Drysdale and Shiro Armstrong

Editors

East Asia Forum