The Global Financial Crisis (26) – Outlook for China 2010 / 2011

Summary

#  Looking at Chinese statistics and recent developments – without considering statistical quality at this point – leads to the (current) conclusion that China has managed the global financial economic crisis quite well. However, good economic growth was maintained by massive injections of fiscal stimuli and incredibly easy monetary conditions for new credits. Of course, these enormous injections into the economy now lead to concerns about the quality of new loans, of new investments and future inflation. Around 60 per cent of the big stimuli package has gone – or is about to go – to state-owned companies. This tells us quite a bit about future risks for the banks and the economy as a whole.

Current cautious measures to reduce the rapid rate  at which new loans are granted are not a wise precautionary step to dampen speculation and overheating – as it has been said in many comments – but rather an attempt to minimize damage after last year’s Formula 1 speed.

#  New own China Survey (Feb, prel, final results after New Year’s vacation):

Overheating indicator: 8.4 (peak since its start in fall 2004,  Mar 2009:3.9).

Forecast GDP growth 2010: 9.4 percent     2011: 9.0 percent.

#  Still, my own main scenario – which I made before the panel survey – is that China will achieve quite a good GDP growth in 2010, in the range of 9-9 ½% percent, despite more tightening of credit conditions and uncertain global conditions. Two interest rate hikes by totally 0.54 percentage points are implemented in this rate forecast. This is not a very scary tightening (however, it could turn out to be somewhat more than this). In all: The risks for this year’s development should not be neglected, particularly when it comes to inflation. There is a non-negligible probability that inflation will exceed the unofficial “comfort ceiling” of 4 percent.

#  More skepticism should be applied to 2011 – unless the global economy recovers more rapidly than currently expected. Next year, fiscal emergency stimuli will run out, credit conditions will be tighter, and the Chinese currency may return to its previous state of appreciating cautiously. Many imbalances will be – or remain – in place next year, too. For this reason, a somewhat lower range for Chinese GDP growth seems to be appropriate in 2011, around 8 ½ – 9 ¼ percent.

A warning may well be in order: China (risk) forecasts should be prepared more carefully than in the past. Following the herd is not good enough anymore.

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Recent and short-term future developments

Economic policy: This fourth generation of Chinese political leaders gets its main legitimacy from good economic growth, often defined as GDP growth not below 8 percent and up to the potential growth rate of 9 – or more exactly – 9 ½ percent  This range functions as a limit to growing unemployment on the lower side and – increasingly – as a ceiling against overheating in the economy. Awareness of this reality helps to understand the gigantic stimulus packages at the end of 2008. They contained mainly investment measures with the objective to significantly improve public investment (investment in total equivalent to 587 billion USD) and an order to the banks in late 2008 to flood the economy with new credits and cash, allowing a 28 percent increase in the money supply M2 over the past year. New credits in 2009 were three times the average of the years before. Foreign companies made direct investments (FDI) to the tune of a massive 90 billion USD in 2009. Thus, foreign confidence in China’s future remains high.

GDP growth / New China Survey No 10:

Chinese GDP growth in 2009 became more than I and most other China observers expected one year ago. I just missed one factor in the GDP forecast but, consequently, about 2 percentage points in additional growth. This mistake was caused by the underestimation of the strong growth contribution from the extremely loose credit policy by the PBoC. One may say that 8.7 percent GDP growth in 2009 (on average) and the 10.7 annualized growth rate in the fourth quarter 2009 have – and still have -  elements of dumping, like the huge fiscal package which runs through 2010.

These assumptions should be favorable enough to give China a GDP growth rate in the range of 9-9 ½ percent in 2010. In 2011, however, domestic growth forces may decline somewhat due to a tightening policy of the central bank and markedly less ambitious governmental investment plans. No major change should be expected in private consumption during the next two years. Thus, another big question is how exports will perform in the forthcoming quarters. All in all, I currently see a somewhat lower GDP growth forecast range for the year 2011, i.e. between 8 ½ and 9 ¼ percent. But this would not be bad either. China’s structural challenges are more long-term oriented.

At the same time, there are some preliminary results of my latest China Survey from February this year. (The final results will be published later in February). The most striking impression seems to be that our overheating indicator has reached its highest level since its start more than five years ago (8.4 compared to the previous peak at 7.9 in fall 2007, scale 1 – 10). Another interesting indication is that the panel so far expects some cooling off in 2011 which is line with my own expectations (Panels forecast: GDP qrowth rate 2010: 9.4 percent, 2011: 9.0 percent). Considering this forecast ceteris paribus: It will depend on the contribution of exports to economic growth whether the domestic overheating in China will become a less urgent problem or not.

Inflation:

Chinese inflation is now running at almost 2 percent – with a continuous upward trend (which also can be explained by the large rise in money supply without being a dogmatic monetarist). Sure, Chinese officials are worried about the worsening outlook for inflation. These worries, however, still are not reflected in the stance on monetary policy which remains quite loose. Recovery aspects are obviously still part of monetary policy, so far leading to a compromise that cannot effectively attack the roots of China’s inflationary threat. There is an obvious risk that Chinese inflation later this year can go through the unofficial “comfort ceiling” of 4 percent.

Credit policy / Monetary policy:

The risk is obvious that the government’s far too loose monetary policy – we could also call it credit policy like in the old Western days-  has contributed to the dumping of money into risky or unprofitable projects. Speculation was has flourished even stronger in the past 12-14 months. This may result in new, major credit losses for the banks a couple of years from now.

For this reason, it seems to be hard to understand why the OECD in its report on China published some days ago came to the conclusion that China “with the help of stimulus action, now is leading the world out of recession”. Even many Chinese economists have a more skeptical view of the contents of the stimulus packages than the OECD and most Western observers.

What gives even more reason for concern are the attempts by officials from the PBoC  to explain that their recent tightening still means an expansionary monetary/credit policy (i.e. despite the rise in the banks’ cash requirements at the PBoC, somewhat higher rates for T-bills and somewhat tougher payment rules for second-home buyers).  Assuming the continuation of an only slightly more restrictive policy by the central bank, there will still be at least twice the amount of new loans as in the years before 2009. Furthermore, if a negative inflation outlook is added, a more officially announced shift from favoring growth to some more efficient fight against credit exuberance and inflation should come in the forthcoming quarters, and may already be announced during the People’s Congress in March.

China must combat its financial imbalances, even if a considerable number of experts reject the conclusion that China is already being confronted with a dangerous bubble in the property and stock markets. What should not be neglected either is that inflation above 4 per cent is very unpopular in the political sphere because of the negative impact on the distribution of income.

The most likely scenario is therefore that China this year will go for at least two interest rates hikes with 0.27 percentage points each time (2+7=9, good number; 2+5=7, bad number). Another one or two hikes within the forthcoming year would certainly not be a surprise if GDP growth has become established on a relatively steady course. Anyway, credit and monetary policy will be characterized by the two goal conflicts described here, between credit expansion/asset speculation and higher inflation expectation on the one hand and growth/unemployment considerations on the other.  The unclear future stance of the PBoCs monetary/credit policy adds, of course, to uncertainty on the Chinese stock market which mostly is liquidity-driven.

Exchange rate policy:

China appreciated its currency against the USD by 20 per cent between the introduction of its more flexible exchange rate policy in July 2005 and the start of the severe global crisis in fall 2008. Since the latter part of 2008, China once again prefers a more or less fixed rate against the American dollar. I expect a return to the previous cautious Chinese appreciation policy in the latter part of 2010 or the first half of 2011 – but not before a more stable and good export performance has become visible for at least a couple of months. The developments of exports should be the benchmark for the Chinese exchange rate policy in the forthcoming quarters.

The increasing international role of China:

Recent developments show the increasing number of Chinese top positions in international ranking (by size, not per capita). An unemployment rate close to 10 per cent in the U.S. and a GDP growth rate in China of roughly 10 per cent can lead to economic and verbal conflicts between the two economic superpowers in the U.S. election year of 2010. China’s gradually decreasing interest in U.S. T-papers will continue. On the other hand, Chinese FDI expansion abroad has only just begun – as has the strategy to gain international financial influence, as recently seen by the Chinese offer to lend money to Greece and Moldova.

An unknown parameter is to what extent China will be acting in order to become the number two economy in the world already this year. Chinese progress in the past two decades has been remarkable. When I recently visited China, I noticed a lot of self-congratulation on different global rankings. On many occasions, the Chinese – when referring to the financial crisis – pointed out all the shortcomings of Western democracies and the problems in Western-style capitalism. Increased self-confidence also means that China will promote its domestic positions globally more than it has done in the past.

Furthermore it should be noted that China has become the main driver of commodity markets. This development affects Swedish companies and, of course, companies in the region of Jönköping as well.