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China Feeling the Effects of the Global Financial Crisis - Will They Avoid Hard Landing?

Oct 28, 2008
Author: China Editor

October 28, 2008 - China's GDP growth slowed to 9 percent in the third quarter from 10.1 percent in the second. As the global economy is expected to slow, China's growth may weaken further, although it may avoid a hard landing, according to the world’s top economists.

At the National People’s Congress last week, Wu Xiaoling, vice-chairwoman of the Financial and Economic Committee, sounded a cautionary note. She warned that in the next two or three years, China could face more difficult times than during the 1997-98 Asian financial crisis. Wu said the current situation is grimmer than a decade ago because the proportion of the country's exports to GDP is higher while the problem of overcapacity could lead to reduced investment in such sectors as steel and electricity generation.

The real estate bubble has taken housing out of the reach of many while car sales meet the bottleneck of high oil prices and environmental constraints, she said. "It is challenging to boost economic growth by encouraging people to spend," she said. "We should get prepared for difficulties."

Two of Hong Kong-listed Smart Union Group's factories in Guangdong closed their doors on October 15, leading to the loss of more than 6,000 jobs. Six days later, the Ministry of Finance raised the export rebate for toy manufacturers. These two incidents are a clear indication of China's economic scenario: Struggling manufacturers and exporters, the loss of a large number of jobs, slowing economic growth and a prompt response from the government.

And more than that, they send an unmistakable signal that the global financial crisis is no longer a financial disaster. It has evolved into a real economic catastrophe that has swept not only the United States and Europe, but also faraway corners of China.

As Paul Krugman, this year's Nobel economics laureate, points out: "Even if the (US) rescue now in train succeeds in unfreezing credit markets, the real economy has immense downward momentum.""

Many problems in the United States, such as those concerning credit cards and non-financial corporate losses, are yet to surface," says Zhao Zhong, senior consultant with Beijing Adfaith Management Consulting. "It is too early to conclude that the worst time has come."

So far China's export growth has held up well, given the slowdown in the world economy, underscoring China's strong competitiveness.  However, we do think that a further slowdown is likely later this year and into 2009, given that the worst of the global financial turmoil, and its impact on the real economy in the rich countries and many emerging markets, is still unfolding.

Standard Chartered Bank (China) in its latest report reduced its China GDP forecast for this year to 9.6 percent from 9.9 percent, with fourth quarter growth further dipping to 8.6 percent. For the next year, the growth estimate would be a poor 7.9 percent while it is even lower at 7.1 percent for 2010. "We are putting them on downgrade watch," said the report.

Ha Jiming, chief economist of China International Capital Corp, agrees. "The hard times will not last for months, but for years," he says. "Even 2009 will not be the bottom (for the Chinese economy)."

This gloomy outlook sounds an alarm for Chinese policymakers, who have seen the economy expand by an average 10.6 percent over the past five years and more than 9 percent on average for the past three decades.

How Will China Avoid a Hard Landing?

The country has taken a slew of monetary and fiscal measures recently to boost growth, including two cuts in interest rates and banks' required reserve requirement, or proportion of money lenders must hold in reserve.

"If there are signs of further economic weakening and sapping investor confidence, policymakers may further cut interest rates or the bank reserve requirement," said Ma Ming, economist with the Beijing Institute of Technology.

China will cut interest rates again this quarter after inflation eased and the global financial crisis sapped economic growth, according to all nine economists in a Bloomberg News survey. The key one-year lending rate will fall 27 basis points to 6.66 percent, according to seven of the economists. Two predict a drop of twice that size.  

China cut borrowing costs for the first time in six years on Sept. 15, the day U.S. investment bank Lehman Brothers Holdings Inc. filed for bankruptcy. It moved again on Oct. 8 as the U.S. Federal Reserve and five other central banks made emergency coordinated reductions to counter the global financial crisis. ``

The economy is still growing strongly but cutting interest rates is like taking out insurance, to make sure that the pace doesn't dip below 8 percent,'' said Kevin Lai, senior economist at Daiwa Institute of Research in Hong Kong. ``China needs that level of growth to keep creating jobs as the population grows and people move from the countryside to the cities.''

China is boosting infrastructure spending and raising tax rebates for exporters of textiles, clothes, toys and medicines. The central bank has also cut the proportion of deposits that banks are required to set aside as reserves and eased quotas that limit their lending.

The fundamentals of the Chinese economy remain sound and the country can cope with the challenges posed by the worsening global financial crisis, central bank governor Zhou Xiaochuan told legislators last week. Despite the impact of the global financial crisis, Zhou said "we should recognize that the overall economic condition is good, our financial institutions are generally strong, with increased profit-making and risk-fending abilities, market liquidity on the whole is ample and our financial system is sound and safe".

Moreover, continuing urbanization and industrialization, which generate huge investment demand, as well as the large domestic market and low-cost labor, mean the basic economic growth track will not deviate much, he said.

Lin Yifu, senior vice-president and chief economist of the World Bank, also said the impact from the global financial crisis on China would be "limited". In the era of globalization, no place is a safe haven but China's economic condition is one of the best compared with others, he said at Peking University on Saturday.

"The financial crisis will definitely have some impact on the Chinese economy," says Liu He, deputy director of the Office of the Central Financial Work Leading Group. "But China is a very big country, which offers it much room to adapt to reduced foreign demand." Moreover, China has ample deposits, providing potential liquidity for economic growth, analysts agree.

What makes China confident of maintaining sound economic growth is its fiscal prowess, says Zhuang Jian, a senior economist with the Asian Development Bank in Beijing. Although the country's fiscal revenue growth dropped to 2.5 percent in September from more than 30 percent in the first half of this year, Zhuang says the around 30 percent annual growth in its tax revenues over the past five years provides enough for any economic bailout plan."

China's fiscal soundness has been much better than it was during the Asian financial crisis in 1997-1998," he says. Back then, China suffered from both sluggish domestic demand and a lack of liquidity, and it had to issue large amounts of treasury bonds every year to bolster economic growth. "Nevertheless, China got through that crisis."

This time, the Chinese government has issued a number of policies to relax lending, increase export rebates and encourage home buying, and more are expected to be in the pipeline. Zhuang says the effect of those policies will be felt in the first half of next year.

UBS economists hold a similar view. "While China should certainly slow over the next few quarters, we also foresee stabilization and recovery by the middle of the year," says a UBS report. "We simply don't see any real possibility of a sudden breakdown or economic collapse."

Last week, Vice Premier Wang Qishan reiterated the pledge at the 5th China-ASEAN (Association of Southeast Asian Nations) business and investment summit in Nanning, capital of the southwest Guangxi Zhuang Autonomous Region. He noted China had "confidence, conditions and capabilities to overcome any difficulty or challenge."

China had undergone several major economic ups and downs since starting its reform 30 years ago. Each was triggered by overheating, partly resulting from decentralization, or pricing policy shifts or foreign exchange system reform.

Among the ensuing macro controls, the one in the 1984-1986 period was given up halfway; the one in the 1989-1990 period caused a hard landing. The macro-control drive in the 1993-1996 period ended with relatively serious deflation, because no timely turnaround was achieved for the then tight monetary policy.

China has accumulated rich experience and drawn enough lessons during the process of overcoming a hard landing. It has shifted from the previous reckless regulation approaches to fine tuning, step-by-step actions and flexible and comprehensive use of multiple methods.

Macro-control measures now include such economic instruments as price adjustment, taxation and credit extension, and legal and administrative means, instead of the mandates and central planning in the past.

The country has learned from experience over the past three decades that every major economic adjustment was followed by industrial restructuring, technological innovation and institutional reform, which drove the nation into a new era of economic growth.

China must replace exports with strong domestic demand to achieve "both macroeconomic stability and sustained economic growth in the face of negative external shocks." But, consumption as a percentage of the Chinese economy has been declining recently, falling from about 60% of the economy in the 1978 to 2002 period, to about 35% today. Authoritarian states can do many things, but they cannot force people to shop. And that is especially true of China, which has almost no social safety net and few public services. Worse, Chinese consumers are bound to become even more cautious now that property prices are tumbling all along the country's coast, and stock prices have lost almost two-thirds of their value this year.

Counting on Chinese consumers, however, may not be a sure bet. Some economists had thought that increasingly wealthy Chinese, with their appetite for cars, mobile phones and Big Macs, could help fill the breach opened by retreating American spenders. But that hope, too, is fading. Though Chinese spending is so far holding up — retail sales of consumer goods jumped 23% in September — household consumption, at only 40% of GDP (compared with about 65% in industrialized countries), isn't yet substantial enough to maintain China's high growth rates. "I don't think [domestic spending] will replace what has been lost in exports," says UBS economist Wang Tao. Nor will it offset another weakening pillar of China's economy: real estate. Rampant construction of new office towers and apartment blocks in recent years was a huge boon to growth. But government action to cool down the market, by, for example, restricting credit for property development, is resulting in a sharp falloff in construction. After 35% growth in real estate investment in the first half of the year, Wang estimates that growth dropped sharply to some 20% in July and August. The property sector accounts for about a quarter of all fixed-asset investment in China and about 10% of national employment. A slump could drag down other sectors like steel production. "Beijing cannot afford a collapse in the housing market," wrote Jing Ulrich, chairman of China equities for JPMorgan, in a recent note to investors.

Government action could shield the Chinese economy from the worst of a global slump. Indeed, economists currently say China ought to remain a relatively bright spot amid the economic gloom. Merrill Lynch estimates that China will account for 40% of world GDP growth in 2009. Continued strong Chinese demand for raw materials, machinery and consumer goods is expected to prop up other Asian economies — the region as a whole is projected to dodge a recession next year.

But even when growing at a double-digit rate, China's economy is not yet large enough by itself to keep the global economy surging. The country accounts for only about 5% of total world GDP; the U.S. is responsible for 28%. "China's strength can help," says UBS's Wang, "but it's not enough to save the world."


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