There are silver linings to the 8.1% first-quarter GDP growth China has just announced, it slowest year-on-year growth rate in three years, and below expectations. The first is that growth in the final month of the quarter picked up once the early new year distorted first two months were done. That momentum should carry through into the second quarter, particularly I’d the central bank continues to pump credit into the economy as it started to do again last month. The second is that consumption spending’s share of first quarter growth was a high 76% while that of fixed-asset investment fell to a low 20.5%, suggesting a continuing tilt, albeit at slight one, towards rebalancing.
Tag Archives: economic growth
China may be looking at spending 600 billion yuan on extending its already over-indebted toll road network. This is another sign, to this Bystander’s eye, that an economic stimulus package in the form of transport infrastructure spending is in the making, but it also raises a red flag about tackling slowing growth this way.
Caixin quotes transport ministry spokesman He Jianzhong saying that the country’s toll roads’ aggregate debt, at 2.32 trillion yuan in 2011, was equivalent to 64% of its accumulated investment of 3.65 trillion yuan, still well short of the 80% he said banks use as a red line when determining whether to grant loans. He says that means toll-road building “still merits bank lending” — 600 billion yuan-worth by our back-of-the-envelope calculation.
Setting aside the thought that there is more sophistication to Chinese banks’ credit risk analysis than that calculation (not something we do with full confidence, it is true), we are surprised that toll roads, some of which are not even earning enough from tolls to cover their existing debt service, would be the recipient of such new investment. The whole system is troubled. Recent political pressure has been to cut the cost of tolls, which are expensive and unpopular with drivers, and to crackdown on illegal toll taking. All this puts further financial pressure on toll-road builders and operators.
Some new toll-road lending has already gone to refinance old loans incurred in the three-year road building frenzy that followed China’s post-2008 global crisis stimulus spending. It is a microcosmic warning of the long-term dangers of relying on fixed-asset investment to generate growth, as China has done. In the end the debt becomes unsustainable.
That China’s economy is slowing shouldn’t come as a surprise to investors. Even a one-party government that depends on growth for its political legitimacy has been signaling that. Policy has been aimed at managing both the cyclical and structural slowdowns so they are orderly (i.e., not politically destabilizing), ensuring the so-called soft, not hard landing.
The latest measure of factory activity underlines how the weakness of demand in the developed economies is hitting exporters. The flash (preliminary) HSBC purchasing managers’ index (PMI) for March, which is weighted towards export-dependent small- and medium-sized manufacturers, fell for the fifth consecutive month, to 48.1, from February’s 49.6. Any number below 50 signals contraction. The official PMI, which captures more activity at large and state-owned enterprises, will likely come in higher, at it customarily does.
For policymakers, the question is whether the lack of demand for the output of factories can be alleviated by making more credit available. As the U.S. Federal Reserve has found out since the 2008 global financial crisis, if underlying demand is nonexistent, it doesn’t matter how cheap the central bank makes credit. Even if pumping credit into the economy is deemed necessary–and the People’s Bank of China has been doing that of late after tightening lending and reining in the property market over the previous 18 months–Beijing’s policymakers have crude monetary tools at best. They can cut banks’ reserve ratio requirements (the capital banks have to keep in reserve against potential bad debts), or they can cut interest rates.
They are constrained on both fronts. Persistent worries about how hard banks could be hit by loans to property developers and local governments turning sour demand that an adequate capital cushion is maintained. Reserve requirements are being relaxed only selectively, such as for the Agricultural Bank of China, the country’s third largest lender and which has just reported its first drop in quarterly profit since its stock market listing two years ago (via Bloomberg). Persistent inflation concerns, again highlighted by the PMI figures, limit the scope for interest rate cuts.
Government-created demand looks the more likely alternative, despite the potential long-term costs (price distortions, misallocation of capital and unsustainable build-up of debt), and yet further delay to the necessary rebalancing of the economy. Yet fixed-asset investment has been the go-to GDP machine. The massive transport infrastructure plan approved by the State Council on Wednesday is starting to look like the outline of a new stimulus plan.
With February’s economic indicators starting to come in, we can get a better measure of the extent to which China’s economic growth is slowing down. With New Year falling in February last year but January this, it takes looking at the data from the first two months of the year together to smooth out that seasonal factor, which inflates the consumer price index, lowers industrial production and skewers the trade figures (though February’s trade deficit is such an outlier that it bears further inspection, especially the leap in oil imports).
What emerges from the combined monthly figures undoubtedly shows a slow down, but not a collapse. Neither is scarcely news, but we are looking for degree. Take value added industrial production; up an average of 11.4% in the first two months of this year over the same period a year earlier. That, though, is the slowest growth rate in nearly three years. Fixed asset investment, the driving force of growth, was up 21.5% year-on-year in the first two months of the year. That is down 2.3 percentage points on a year earlier and the slowest increase since 2002. Retail sales were up an average 14.7% year-on-year. In December they were up 18.1% year-on-year. Vehicle sales were down 6% year-on-year in January and February.
Those last two numbers bear continued close observation. They hint at weak domestic demand at the same time export demand is weak in the face of the sluggish growth in the U.S. and European economies. With inflation averaging 3.9% across January and February, well down from its 6.5% peak last July, real domestic interest rates are still negative.
The best proxy of the true growth rate of China’s economy may be power generation, which was up 7.1% year-on-year in the first two months of the year. That is skirting close to the minimum that is politically acceptable; indeed 7.5% is the official target for the year, though the current-five year plan calls for an average annual growth rate of 7%. With inflation falling, but not fully under control, ditto fixed asset investment and real estate prices, and nagging doubts persisting about the quality of the banks’ loan books, policymakers still must be cautious in further monetary easing.
Monday’s publication will push the World Bank’s report, China in 2030, to center stage in the emerging, if ultimately pointless debate about whether China’s state-directed capitalism is better than the U.S.’s free-market capitalism. The later has undeniably damaged its case with the self-inflicted injuries that caused the 2008 global financial crisis. The revival of the 1930’s blend of banker and gangster, bankster, is timely and apt, in that regard, just as are the Occupy protests that have sprung up around the free-market world. But, in their rush to throw out some fetid bathwater, capitalism’s critics risk tossing out the baby, too. Nor is the Chinese model a proven substitute. For all that it has seen China though the post-2008 crisis period with higher growth rates than the Western Economies, the long-term costs have yet to fall due.
The World Bank report reportedly argues that the dirigiste model that has seen China through a remarkable three decades of economic development has run its course. We don’t yet know the details of the Bank’s arguments, but this Bystander has long argued the necessity of structural change if China is to move up the development ladder. The heart of the real test for China’s state capitalism is not whether it is better than banksterism. It is, can it vault the country from the ranks of poor countries to rich. To do so, it will need to clear the middle-income trap or the economic Great Wall–choose your metaphor–something no developing country has done without institutional change. This Bystander thought it timely to republish China’s $10,000-12,000 Question, first published in January last year, examining whether China can defy history:
Whether political reform is an inevitable consequence of China’s economic reform has been a longstanding question. Ilian Mihov, an economics professor at INSEAD, the Paris-based business school, flips the question on its head. He asks whether the country’s ability to develop its economy rapidly can continue without institutional reforms regarding the rule of law, governance and accountability.
In a recently published report of a session on China at an INSEAD symposium in Singapore last November, Mihov said China needs “deep structural reforms”. Command economies can only sustain fast growth with weak institutions for so long. The tipping point comes when per capita income reaches $10,000-12,000 a year, the point at which developing economies tend to stop developing without institutional change (see chart below)*.
“There is not a single country that has good quality institutions and is poor,” Mihov said in Singapore. “The gap between rich and poor is driven by poor productivity that is linked to poor quality institutions and poor business environment.” As evidence he offers the contrasting experiences of Singapore and Venezuela. Even more dramatically, consider the economies of the old Soviet bloc, which collapsed as per capita incomes hit and then got stuck at the $12,000 a year level (adjusted for current prices).
China’s annual per capital income is $4,000. At current growth rates that gives it less than a decade before it starts bearing down in earnest on that tipping point or The Great Wall as Mihov inevitably dubs it.
What makes for the aforesaid poor quality institutions and a poor business environment includes political instability, government inefficiency and the prevalence of corruption. Those are factors within government’s control. There has been progress, albeit piecemeal, as with, for example, the current anti-corruption campaign and the improving quality of China’s civil, if not criminal courts. There are other reasons than planning for long-term economic development for those changes, but the $10,000-12,000 question is whether that progress continues at a sufficient pace to carry the country through the transformation to a new peak of development. Or will it be left stuck on the plateau of stagnation?
The growing economic and political clout of state-owned enterprises is another possible impediment to progress. Like Japan before it, China has grown fast by replicating and improving on what advanced economies have already done and producing and selling the results much more cheaply. Yet, as Japan found out, there comes a point where innovation has to replace imitation if growth is to be sustained.
China’s state-owned national champions and aspiring multinationals are ambitious, adaptive and fast learners (as were Japan’s). They are developing R&D and product development capabilities but they remain reliant on access to low-cost capital from the state, have rudimentary organizational and financial management skills by the standards of multinationals and have yet to acquire two of the most essential traits of a globalized multinational, managing diversity and allowing the intrapreneurship in which innovation can flourish (traits that few Japanese multinationals were able to acquire).
Beijing is throwing a wall of money and of engineers and scientists at making its national champions more innovative (dealing with diversity isn’t even on the radar). Yet in the process of building up the SOEs it is distorting markets and entrenching vested interests that increase the resistance to reform. It also crowds out small and medium sized companies where growth-generating innovation truly flourishes. Those need a particular business environment which is possible only with good institutions and a regulatory and governance regime that may not be to the taste of big business in the form of the SOEs, who see their (patriotic) role to be competing with other multinationals not fending off pesky upstarts at home.
That sets up a dilemma for the leadership. If the Party’s legitimacy to monopolistic rule depends on continuing to deliver the economic growth that keeps its citizens getting richer and Mihov is right that the country’s rapid economic growth cannot continue beyond a certain point without institutional reform, then managing the role of government in the economy and overcoming state-owned vested interests — in other words reforming itself — becomes China’s policy planners most important concern.
*There is a 2009 research paper on the $10,000-12,000 barrier by Mihov and his colleague Antonio Fatas, The 4Is of Economic Growth, from which the chart above was abstracted. A summary focusing on China, Another Challenge To China’s Growth, was published in the Harvard Business Review of March 2009.
The World Bank’s latest Global Economic Prospects makes grim reading. It forecasts that the continuing ripple effects from the 2008 global financial crisis will slow world economic growth to 2.5% this year, with the eurozone contracting. In June, the Bank had forecast 3.6% growth for the global economy. “Even achieving these much weaker out-turns is very uncertain” the report’s lead author, Andrew Burns, writes on his Bank blog. The world faces “a year fraught with uncertainties”.
For China, the Bank forecasts that GDP growth will fall to 8.4% in 2012, down from 2011’s 9.2%. June’s forecast had been for 8.7% growth this year. As the Bank points out, 8.4% growth is “still robust” and it expects authorities “to continue to dampen ‘overly-fast’ growth in a number of economic sectors”. It adds that “the prospects for a soft landing for China remain high”.
Nonetheless it sees three downside risks to its growth forecast: trade growth slows even further in the event of a serious deterioration in Europe’s economies; the capital outflows from emerging economies, including China’s, seen in recent months turn into full spate; and China’s real estate market, which the Bank says is arguably still overinflated, weakens further. Local government borrowing and bank balance sheets are co-joined risks.
In June, the Bank had forecast growth would pick up modestly in 2013, to 8.8%. Now, it says growth will slow further next year to 8.3% “in-line with the country’s longer term potential growth rate”.
That pace of growth is starting to skirt the 8% that is always held up as the minimum needed to ensure social stability. It may force some concentration of minds on the need to push through structural reform to rebalance the economy away from export- and investment-led growth to domestic consumption. Or it may just make nervous party leaders in the midst of a leadership transition more determined to hunker down.
Footnote: This is the Bank’s summary of China’s prospects, from the East Asia-Pacific regional sector of the outlook:
In China, the lagged effects of monetary policy tightening (both in terms of interest rates and regulatory adjustment) are expected to combine with weak external demand to slow GDP growth from 9.1 percent in 2011 to 8.3 percent by 2013. The bulk of activity is expected to come from domestic demand―with private consumption and fixed investment contributing 3-and-4 percentage points to GDP in 2012―while net exports afford only a modest 0.2 point addition to growth. Inflation is anticipated to decline; and monetary policy relaxation could be in the cards during 2012. Key domestic risks for China are the property sector, local government borrowing, and bank balance sheets; but the baseline scenario envisages that policy will focus closely on these aspects, with efforts sufficient to stem systemic effects on the economy.
China’s economy continued to slow in the fourth quarter of last year, though not by as much as many economists, if not us, had expected. Gross domestic product rose by 8.9% in October to December, compared to the same period a year earlier, the National Bureau of Statistics announced. The fourth quarter growth was the slowest for 10 quarters, and the first time the growth rate had fallen below 9% since mid-2009. Full-year GDP growth for 2011 came in at 9.2%, down from 2010’s 10.4%. The cooling of the domestic property market and the moderation of demand in China’s Western export markets have taken their toll on expansion, the one intended, the other not.
Policymakers have been pumping credit into the economy since late last year. That is likely to continue–monetary easing by way of a backdoor stimulus. The questions now are how much will be needed to keep a hard landing at bay, and how much can be risked without re-stoking inflation, which, while down from July’s 6.5% peak, is still ahead of the government’s target of 4% for the year, coming in at 5.4% for 2011. The property bubble has been deflated not punctured and still rising food prices remain a concern, the latter being both politically sensitive and the part of the consumer price index least responsive to monetary policy. Ma Jiantang, head of the statistics bureau, warns that inflation could easily reverse this year its fall in the second half of last.
Given that, and the uncertain outlook for the global economy, particularly its European component, Beijing’s policymakers will have to walk a fine line, a task made more difficult politically by the leadership transition now underway. It is also likely to make policymakers and politicians alike more nervous of tackling the changes needed to rebalance the economy in the longer term, away from export- and investment-led growth and towards domestic consumption. If anything, the higher than expected fourth-quarter GDP numbers bolsters the status quo. It will reinforce the view of the economic conservatives that it is better not to mess with the tried-and-tested mechanism of stimulating the economy via new loans from large state-owned banks to equally politically reliable large state-owned enterprises, as it appears to be forestalling the immediate danger at hand.
The World Bank has raised its forecast for growth in China this year to 9.1%. In March the bank had forecast 9.0% GDP growth. But it sees growth slowing next year to 8.4% against the background of a slowing global economy. That will also put the brakes on regional growth already hit by the flooding in Thailand that has disrupted manufacturing supply chains.
In its semi-annual regional economic outlook, the bank highlights the Chinese economy’s vulnerabilities to the debt crisis in Europe and the heavy endebtedness of local governments at home, which it says may be exacerbated by the central government’s success so far in dampening the property bubble. “Policymakers will need to walk a fine line guarding against the short-term risks to growth and the lingering vulnerabilities associated with a still buoyant, if not overheated, economy,” the bank says. It also notes that the moderation in inflation gives policymakers scope to manage a soft landing by loosening their monetary tightening.
The bank also says that the slowdown in global growth provides an opportunity for governments to refocus on reforms that will boost growth in the medium- and long-term, including investment to increase productivity and move toward higher value-added production, a task it calls “urgent” for China’s coastal manufacturers. In a clear nod to Beijing, it also says that where investment levels are already high, increasing the quality and efficiency of these investments should be the first priority alongside rebalancing growth towards domestic consumption. To drive ahead the structural changes in China’s economy, the bank repeats its calls for Beijing to focus on completing the transition to a market-based economy and strengthen the national innovation system. The China-specific part of the outlook is here.
Inflation spiked in March, with consumer prices up 5.4% year-on-year, their fastest growth in nearly three years (via Xinhua). February’s holiday-distorted inflation number was 4.9%. March’s rise confirmed the worst expectations of many economists following the central bank hiking interest rates again earlier this month. The tightening in place since last October, when the rate-rises started, has barely braked the pace of economic growth. GDP grew by 9.7% year-on-year in the first quarter, against 9.8% in the fourth quarter of last year, more robust growth than policy makers would like. With inflation expected to peak mid-year, though global commodity prices are a wild card, the gradual tightening (and yuan appreciation) will continue as the pendulum of concern swings back towards inflation.
The IMF’s latest World Economic Outlook left its projections for China’s GDP growth for this year and next unchanged at 9.6% and 9.5% respectively, a slight slowdown from the 9.8% by which, the IMF estimates, the economy grew in 2010 and ahead of Beijing’s own forecasts. A set of traffic light warnings on whether the economy is overheating are mostly at amber.
The Outlook also devotes a sidebar to the lessons of Japan’s bubble in the 1980s and the effects of the rapid appreciation of the yen, forced on Tokyo by the Plaza Accord of 1985. The piece starts by saying that “some argue that this is a cautionary tale, exemplifying the dangers of reorienting economies through currency appreciation” and sourcing the some to the People’s Daily, so it is pretty clear where the lesson is directed. Not that that is any surprise given that the IMF has long been a critic of China’s slow appreciation of the yuan, a process being tightly managed by Beijing because of the risk of social dislocation.
The IMF authors’ central argument is pretty clear: the rapid appreciation of the yen wasn’t the cause of the Japan’s “lost decades”. The sequence of events is unquestioned. The yen’s rapid appreciation stopped Japan’s export and GDP growth in its tracks; the government responded with a big stimulus package; an asset bubble was inflated that went pop in 1990 and the economy has essentially been becalmed since.
What is put at question is whether the stimulus was excessive (yes, say the IMF’s authors) and whether it alone was responsible for the bubble (no, they say; financial deregulation allowing a rapid expansion of bank credit for real estate investment and tardiness in reining it in were also to blame; two factors compounded first by the overleveraging of Japan’s banks that were at the heart of keiretsu, or groups of closely affiliated companies, and then by the political constraints on authorities forcing the keiretsu to restructure and write off their debts which didn’t happen for a decade, allowing time for further policy missteps and external shocks). In short,
The conditions facing Japan were in many ways unique, and the bad post-Plaza outcome was due largely to a credit bubble that developed after exceptional policy stimulus was combined with financial sector deregulation. When the bubble burst, exposing underlying vulnerabilities, political economy constraints meant that restructuring progressed too slowly.
The IMF says circumstances in China today are different from those in Japan in the 1980s so past won’t be prologue. First, China’s households, corporations, and government aren’t as overborrowed as were Japan’s pre-bubble. Second, China has more room to move up the export quality ladder than Japan did, which will help offset the impact on growth of currency appreciation (though risks labor dislocation in low-end export manufacturing), and third, Japan had a floating exchange rate regime in the 1980s, whereas China has a managed exchange rate supported by vast foreign currency reserves and restrictions on capital inflows. “This difference in currency regimes should help China avoid the sharp appreciation observed in Japan,” says the IMF. Which is exactly Beijing’s point.