Saturday, January 14

A slower boat to China

It is only recently become apparent Chinese credit growth has far exceeded western economies during the past 3 years of the current global financial crisis.
China initially injected about $750 billion into municipal councils to thwart the effects of an initial savage downturn in exports which literally fell off a cliff in terms of reduced volume as a conseqence of the GFC.
This stimulus was earmarked for investment spending by municipal councils who augmented these funds with massive loans to invest in infrastructure projects and real estate development to the tune of trillions of dollars in additional credit.

This meant that 60% of the economy was being underwritten by unsustainable investment spending leading to both house prices and buildings ratcheting up in a huge bubble accompanied by marked increases in inflation.

The magnitude of this spending dwarfs the stimulus measures in the west and resulted in a huge buildup in government debt- that is rather a massive increase in municipal debt added to the much more modest 20% to GDP of the central bank indebtedness to total near 100% of GDP- similar to the central government debt in the USA. Victor Shih, a professor at Northwestern University who specializes in China warns that the country has only achieved its blistering GDP growth through massive leverage on a scale nobody currently appreciates. Here's what he wrote in an op-ed in WSJ Asia in regards to figure out the true level of provincial, local debt: To obtain an independent estimate, I collected data from thousands of sources, including regulatory filings, bond-rating reports and press releases of government-bank cooperative agreements. I estimate local investment entities' borrowing between 2004 and the end of 2009 totals some $1.6 trillion. The data are far from perfect because borrowing by low-level government entities and lending by small banks are difficult to track. Nonetheless, my evidence suggests that the scale of the problem is much larger than previous government estimates. At $1.6 trillion, the size of local debt is roughly one-third of China's 2009 GDP and 70% of its foreign-exchange reserves, To read the full article click here

The measures introduced by authorities to curtail the unsustainable bubble and curb inflation gave rise to fears of a crash or hard landing which was initially evidenced by a significant slowdown in imports (halving) and house prices falling 50%. Unsurprisingly this has given rise to pockets of social unrest and corruption out of this boom and bust cycle. Oddly enough as each piece of bad news filtered through to the west (as evidenced by falling prices and reduced demand) confidence grew that authorities would take action to avoid what otherwise might be a very hard nasty landing.

Hence the big questions remains will China be able to curtail this unsustainable investment growth as authorities aim for a soft landing to revert to a sustainable rate of growth or do we need to brace ourselves for a significant slowdown which will affect exporting countries such as Australia?

Anyone who thought that China was immune from the GFC or thought that authorities had a iron clad grip on what was going on need to think again. So we are bound now to see a future slower China with exports curtailed by a struggling Europe, by weak global demand and constrained by less capacity for internally based stimulus measures. Howewver, on a brighter note, once EU countries finally commit to improved budgeting to live within their means possibly in March this year the European Central Bank is likely to loosen the money supply and provide some respite to a recession for the region. This could not come too soon as European leaders have so far shown a marked reluctance to do anthing other tham tinker around the edges as their economies inevitably slide ionto recesion. The degree to which the recession bites, of course, the greater the impact on China as Europe is its biggest customer.

However in China the response by authorities recently has been to loosen the banking ratio reserve( funds banks must keep in reserve)and reduce official interest rates which were cut for the first time in 3-years, by 50 basis points ( Eg .50% ). A much more accommodating monetary policy was made possible by inflation reducing from 6.50% to just over 4% and further easing will no doubt continue this year.

The People's Bank of China, the country's central bank, said on Wednesday that it will lower banks' reserve requirement ratio (RRR) by 50 basis points for the first time in three years in order to replenish liquidity in the country's banking system as inflation eases.
The latest cut, effective on Dec. 5, drops the RRR to 21 percent for large commercial banks and 17.5 percent for mid- and small-sized banks. An estimated 396 billion yuan (62.38 billion U.S. dollars) in capital will be released into the market.
Click here for the full article

Hence it will be a slower boat to China this year. But given the easing in monetary policy and with more to come I think it may still revert to a fair rate of knots- maybe in the order of a growth rate of 7.5- 8% compared to the unsustinable double digits of the past.

The reality is however that because of the buildup in debt China does not have the capacity to further stimulate the economy as it did just a few short years ago. It is not all plain sailing and the policy options remain constrained.

PS China’s economy probably grew the least in 10 quarters in the last three months of 2011 and may cool further as export demand slumps and officials prolong a campaign against property bubbles.

Gross domestic product, the value of all goods and services produced, rose 8.7 percent from a year earlier, the slowest pace since the second quarter of 2009, according to the median forecast of 26 economists surveyed by Bloomberg News. The data, and indicators for investment, retail sales and industrial production, are scheduled for release tomorrow in Beijing.

The fourth straight quarterly slowdown in the world’s second-largest economy adds to concerns that global expansion is faltering, with the International Monetary Fund warning of near- zero growth in Europe and a “substantial” cut to its global forecast. China’s exports rose the least in two years in December and inflation eased to a 15-month low, bolstering the case for Premier Wen Jiabao to loosen policies.

“The worst is yet to come and more easing measures will be in the pipeline in coming months,” said Zhang Zhiwei, Hong Kong-based chief China economist at Nomura Holdings Inc., who previously worked at the IMF. “Increasing downside risks in China will hurt the outlook for other economies especially commodities exporters such as Australia and Brazil.”

Growth may “trough” at 7.5 percent in the three months through March and 7.6 percent in the second quarter, Zhang said. That may prompt the central bank to “front-load” policy easing into the first half, with one interest-rate cut in March and three reductions to banks’ reserve requirement ratios, he said. Read more by clicking here


Mercutio said...

Even with slower growth, China remains a powerhouse.
According to the figures that I've seen, the US is roughly 4% of the world population, and China is roughly 18%.
That's a staggering number.
Such massive industrialization is something the like of which this world has never seen.

It does seem like they shot all their guns at once as far as stimulus goes.
But I believe they are still something of an net exporter.
Slowdown in the Eurozone would naturally tilt China's GDP to the nether-regions a hair, but I think they've got enough growth in domestic consumption to replace it.

Pardon me if I re-stated the issue.

Lindsay Byrnes said...

Hi Mercutio
True, and don’t forget about India and growing Asian countries of our region such as Indonesia which are fast becoming power houses. Some confuse China’s slowing imports and escalating wages as a sign the economy might tank in the future. But targeting higher wages and placing less reliance on exports is a deliberate policy by the authorities seeking greater self reliance from within for their burgeoning economy.
Best wishes