After years of breakneck economic growth, China is finding itself the focus of global uncertainty. Faced with rising domestic inflation, China’s efforts to engineer a soft landing are crucial to the global economy - but its success is by no means assured. Nick Parsons reports.
As the European Union and the US face years of sluggish economic growth - and the more immediate prospect of their own self-imposed debt ceilings getting blown away - China’s role in sustaining the global recovery has never been more apparent. However, the Chinese Government is not celebrating that importance, knowing that its only real economic responsibility is to its own economy. Here, it faces a tricky balancing act in managing a soft landing, while also conducting a major overhaul of economic policy at the same time.
The biggest fear that is beginning to resonate with some foreign investors - but which has long been pervasive inside the country - is that China itself could be the source of the next financial blow-out. Is China going to keep on keeping on growing at such a frenetic pace or is it facing a sobering come-down, close to, what might be called, a crash?
The Chinese economy has a lot of the apparent ingredients to turn boom into bust: property prices gone haywire, loans in danger of becoming non-performing, industrial overcapacity and rising wages - all at a time when the next political succession is looming and the government is determined to re-balance an overheated economy without destroying its growth potential.
For now, it is in that space that analysts are calling “mid-point softness”: the impact of the fiscal stimulus launched in 2009 has waned, but private investments, outside of the housing sector, have yet to pick up. When monetary tightening (or normalisation) takes place, stress emerges.
Most analysts have revised down their forecasts of China’s GDP growth to around 8.5% from nearer the 9.0% mark for 2012 and Dong Tao, head of Asia non-Japan economics at Credit Suisse, is among them.
“Despite signs of growth slowdown, we do not anticipate that the end of monetary tightening is anywhere close to an end. Firstly, inflation is likely to surprise on the upside throughout the second half of the year, and, secondly, the property sector stands at a crossroad, and speculative money could return at any time if a wrong message is sent.”
Others believe China will be able to stave off a sudden drop in economic growth through continued investment, pushing the problem further down the track.
“Chinese growth is in a rare soft patch, but the government’s housing policy will spark a rebound in the second half of the year,” said Adam Wolfe at RGE, an economic research consultancy. “The People’s Bank of China is likely to put the monetary-tightening cycle on hold for most of the second half of 2011, but it will resume tightening in 2012, in response to persistent inflation.”
“There are no signs of re-balancing away from investment-led growth in 2011 to 2012, which will increase the risk of a hard landing after 2013,” concluded Wolfe.
Tao added that, were a hard-landing scenario to become more likely, fiscal stimulus, instead of monetary easing, would be more likely. “Providing funding to policy housing and speeding up infrastructure projects would be the easy options,” he said, but he did not “see Beijing hitting that button during the summer time, at least.” Using interest rates, rather than other monetary policy levers, would make a change from the central bank’s policy so far this year.
Too tight?
The PBoC, for example, announced a 50bp raise in the bank reserve requirement ratio (RRR) in mid-June, its sixth hike since the beginning of this year and taking the cumulative rise, from the beginning of the tightening cycle, to 600bp. Coming immediately after the release of higher-than-expected CPI figures - up on the already record-high inflation figures for May - it highlighted the central bank’s determination to curb rising inflation and also its inability to persuade the banks to rein in their lending, especially to important groups, such as state-owned enterprises, real-estate developers and local governments. It also responded to growing concerns that interest-rates hikes might add to the repayment burden on the loans dished out since the 2009 stimulus.
The PBoC had shown a clear preference for using the RRR to manage the economy, instead of interest rates, in this policy cycle, for two reasons, said Credit Suisse’s Tao: “firstly, the fear of hot-money inflows and, secondly, concerns about the debt burden of the local government investment vehicles”.
However, there have been some unfortunate side-effects from this approach: “Banks keep their best customers, allowing large companies and SOEs to have full credit capacity, but cut smaller companies off from the lending list, [which] has resulted in a drastic tightening in cash flows among small- and medium-sized enterprises and, consequently, in the informal credit market along the coastal regions, lending rates have surged sharply.”
The China Banking Regulatory Commission issued a guideline in May urging banks to ease credit to SMEs after months of tinkering that had inadvertently cut them off. Will banks increase credit to the lower end of their customer list when they are under pressure in an economic downturn? That has to be unlikely. It is the same problem the government faces with housing: it has been trying to dampen a roaring real-estate market, but it will not risk a slump in construction. So, it has come up with a plan to put low-cost housing at the centre of its re-balancing programme.
These schemes are already falling way behind schedule in a manner unknown at the higher end of the property sector and, for the same reason - that it is proving hard to make the necessary reforms to an economy that has benefited such powerful vested interests.
“We have often observed that the Chinese Government retains so much administrative control over so much of the economy that it has been uniquely effective in stimulating and restraining aggregate credit and demand as it deemed appropriate,” said Bill Cheney, chief economist at MFC Global Investment Management, part of the Manulife group. “However, the rapid development of private industry and financial markets may be loosening the control mechanisms, raising the risk of overheating, bubbles and a crash.”
“The run-up in housing prices, followed by recent evidence of sharp declines, is one of several hints that tightening measures could turn out to be excessive, causing the economy to stall before the authorities can shift gears again towards expansion,” continued Manulife’s Cheney. “In any case, the scope for a policy mistake is rising steadily, and a recession in China, however defined, is a real possibility within the next five years.”
Diana Choyleva, an economist at Lombard Street Research, also thinks it is a mistake to believe that China’s command economy means the government is “omnipotent”. Large parts are in private hands and, on this occasion, the government has lost control over the economy. The best the Chinese Government can hope for is growth slowing, warned Choyleva. “Investors in Chinese equities are going to get a nasty surprise.”
Source: Reuters/David Gray
Delicate balance: China’s efforts to dampen inflation risk derailing economic growth.
Spectacular monetary expansion
It is a growing feeling being bandied about the capital markets that all may not be so rosy further down the road. Most particularly, the bank lending that dragged the country out of recovery in 2009 has yet to be tested, but, soon, the shortest of those loans, many to local government trusts and property developers, are set to mature, and the tighter credit conditions will mean governments’ abilities to repay the debt are sure to come into question.
“China boosted the economy too much and they were too late withdrawing the stimulus,” said Choyleva. “China panicked and engineered the most spectacular monetary expansion ever. The bill represented 40% of GDP in 2009 and 40% in the first half of 2010, when the previous actual peak in 1993 was around 30%. So, what happened is the economy overheated and there was a year-and-a-half’s increase in demand by the time the authorities tightened quite significantly”.
The World Bank took a more positive view in its Global Economic Outlook report in June, noting that China’s economic growth had remained “resilient as the macro stance moved towards normalisation”.
“Consumption growth slowed in early 2011, but overall domestic demand held up well, supported by still strong investment growth. Real-estate investment has, so far, remained robust to measures to contain housing prices, a policy focus,” the report said.
However, Michael Pettis, an economist at Peking University in Beijing, argues that the word “resilience” is a polite euphemism for saying that the economy is growing faster than the government has been able to control to the point that it may have now overdone its tightening efforts. “China’s high level of investment is causing a rapid rise in debt and will likely lead to a slowdown in the country’s economic growth,” said Pettis. “They responded to the 2007-08 crisis by taking a country which already had the highest investment growth rate in history and significantly increasing it.” When you increase investment, you always get growth, but, if the investment is not economically viable, you give back all of that growth in the future. “That is what may be happening here.”
