Despite prophecies of gloom and doom, China is moving toward rebound – through stimulus lite.
Not a day seems to go by without still another headline predicting gloom and doom in China. So when the IMF recently cut its growth forecast for China suggesting a hard landing was still “possible,” speculation intensified.
In reality, China’s economy has been recovering since the government’s monetary loosening in fall 2011, whereas major economies in the United States, Europe and Japan are deteriorating.
Gloom and doom stories
Today, most gloom and doom forecasts stem from five stories: a bursting property bubble, local government debt, export-led growth, investment-led growth, and shadow financing.
Property markets. If housing construction continued to decline, that would surely have a negative impact on economic growth. And yet, Chinese home prices rose in June, and the number of cities reporting price gains exceeded those with declines. Despite continued price declines in large numbers of localities, what matters is the trend reversal. Moreover, China’s urban potential remains huge.
Net exports. During the global crisis, many predicted that the negative demand shock from the West would cause the collapse of the economy because exports accounted for 35% of GDP in China. However, GDP is not driven by exports but by net exports (exports minus imports). In fall 2008, net exports were 8% of GDP; today about 4%. A part of it can be compensated as long as private domestic demand remains strong.
Investment. Since the onset of reforms in China, investment in China has climbed from 30% to almost 50% of GDP, while consumption has declined from over 50% to about 35%. In the long-term, consumption is vital to boost well-being in China, but investment remains critical to national industrialization and urbanization, which support poverty reduction and middle-class expansion in less prosperous regions.
Local government debt. Amidst the global crisis in fall 2008, China launched a massive $586 billion stimulus package, which sparked great confidence domestically and supported growth. However, not all of the funds ended in productive uses. Local government debt rose to $1.7 trillion by the end of 2010. Today, regulators are cleaning up old loans made to local government financing vehicles. As long as funding for key projects is ensured and applying the brakes is done appropriately, the debt is manageable.
Shadow financing. If economic growth in China continues to slow, rising defaults on loans made in the country's shadow banking system could threaten China's traditional banking sector. At an estimated 14.5 trillion renminbi ($2.2 trillion), the amount of loans made by shadow banking entities amount to 25% of all the loans made by the traditional, regulated but highly leveraged banking sector.
Each story has a kernel of truth. Under highly adverse circumstances, all could contribute to a growth reversal. In particular, Premier Wen Jiabao continues to warn that recovery was not stable and trouble may continue for some time.
But why the dark prophecies?
Due to the current mood in the West, there is an uneasy obsession with short-term data. It may be more instructive to take a step back and look at Chinese economy during the past half a year.
With U.S. stagnation and European deterioration, Beijing’s policy-makers switched gears in fall 2011, shifting from the battle against inflation to stabilizing conditions for growth. At the time, analysts were revising down their 2012 real GDP growth forecasts – from 9-9.5% to 8-8.5% per annum. That is when the central government initiated monetary loosening.
By February 2012, China was approaching a turning point, as I argued at the time. True, economic indicators had weakened further in December. Still, economy proved resilient in the first quarter of 2012. Inflation fell sharply, but many of the indicators were improving.
As the chorus of gloom and doom got louder in the West, China was already on track for a soft landing.
The good, the bad, and the ugly
In April 2012, the Chinese economic data fell short of market expectations. As a result, some investors became concerned that China would repeat the hard landing of 2008.
Now Chinese policy-makers faced three challenging scenarios. If the global crisis would prove short-term, Beijing could ignore negative developments in the foreign markets because the adverse impact would be brief. In light of the serious challenges in the West, however, this “good scenario” was no longer realistic.
The “bad scenario” suggested that the crisis would prove at least medium-term and, due to the lingering impact, Beijing should promote growth to sustain its strong fiscal position.
In the nightmarish “ugly scenario,” the global crisis was close to a tipping point – a double- or even a triple-dip in the West – that would have a highly adverse impact on China and Asia. This scenario remains possible (especially later in 2012/2013), but it was not seen as probable, at least not yet.
In China, the West was perceived amid a “bad scenario” that may morph into an “ugly” one. That’s when the government seized what could be described as a “stimulus lite.”
From introduction to acceleration
While the basic stimulus lite initiatives were initiated in February, the soft data in April accelerated measures in several fronts.
The National Development and Reform Commission (NDRC) sped up the approval process for major infrastructure projects, including new airports and subway networks.
The People’s Bank of China (PoBC) cut deposit rates by 25bp and lending rates by 31bp. These were not just instruments of policy easing, but steps towards interest rate liberalization.
Fiscal policies are more proactive. The State Council announced a RMB 36.3 billion (US$5.7 billion) subsidy program to encourage the consumption of energy-efficient household electronic appliances, automobiles, and power generators.
New tax cuts are to be expected as well.
The Ministry of Railways obtained large credit lines from banks in 2011, which will allow it to execute a planned investment of RMB 400 billion ($63 billion).
The Chongquing municipal government has signed multiple contracts with 30 major State-owned enterprises, which are expected to invest over RMB 350 billion ($55 billion) in Chongqing in the next few years. This deal provides a blueprint for similar SOE-local government initiatives in the coming months.
Since these initiatives are multidimensional by nature, their combined impact is more difficult to discern. Concurrently, China has sped up the transition from economic reforms to financial reforms, which will eventually support consumption-led growth.
In May, Chinese economic data was still weak. While the crisis in the euro zone entered a far more dangerous phase, recovery in China accelerated in sequential terms in June.
Lower inflation boosted purchasing power of consumers, businesses and the public sector, while trade and lending data point to a growth rebound. Industrial production is picking up. In the second quarter, Chinese GDP growth slowed to 7.6% on an annual basis, pressured by industrial output and trade. It is poised to rebound in the second half of the year, at about 8-8.4% year-on-year.
The “stimulus lite” is likely to support the rebound of inflation and property prices by the year-end. In that case, the window of policy loosening may prove relatively brief.
The stronger than anticipated loan growth, coupled with aggressive rate cuts over the summer weeks indicate that the policy-makers will continue to boost aggregate demand, through reserve ratio requirement cuts, higher lending guidance, continued strong fiscal spending, and more infrastructure investment. The full impact of these measures will become more discernible in the latter half of the year.
In the coming months, the Eurozone crisis is likely to deteriorate further, while the U.S. stagnation will deepen. In the case of a double-dip in the West, China would have to cope with a more challenging landing – but from a position of relative strength.
Dan Steinbock is Research Director of International Business at the India, China and America Institute