Engineered Slowdown

China is still in good health

Issue: Aug 2012

China’s growth is not heading for a hard landing but rather a deliberate slowdown, banking its money on quality and not speed of growth
China’s growth is not heading for a hard landing but rather a deliberate slowdown, banking its money on quality and not speed of growth

Worries of China heading towards a hard landing began to grow after recent economic data suggested some weaknesses. It grew further when the People’s Bank of China (PBoC) made two rate cuts in less than a month. Was the move purely driven by fear that the economy was spiraling down? Such fears warrant no panic. After all, China engineered this slowdown after nearly running into the risk of overheating in 2010. Chinese policymakers have enough monetary and fiscal ammunition to support growth, and the underlying growth trends remain intact. Looking ahead, China’s growth will decelerate with the focus on the quality, rather than the pace of growth.

Major milestones in the past three decades

China has undergone two major economic transformations over the past three decades: from a rural, agricultural society to an urban, industrial one; and from a command economy towards a market-based one. These economic achievements have yielded spectacular results: an average annual economic growth rate of nearly 10% since 1978; poverty rate fell from more than 65% to less than 5%, with over 600 million people being lifted out of poverty since 1981. China is now the world’s second largest economy after the United States; the world’s largest manufacturer and exporter, and the list goes on.

Debate over hard landing resurfaces


Figure 1 : China Gross Domestic Product (GDP) Quarterly Growth
Figure 1 : China Gross Domestic Product (GDP) Quarterly Growth

The debate over hard landing is resurfacing as recent economic data shows a deceleration in growth. 2Q GDP have slowed to a three-year low of 7.6% (Figure 1). This is below the psychological 8% baseline that is viewed as necessary to maintain employment levels, but above the government’s growth target of 7.5% for 2012. Industrial Production (IP) annual growth in June at 9.5% YoY was close to a three-year low and electricity production only grew 2.7% YoY. Both the official and HSBC manufacturing Purchasing Managers Index (PMI) fell again in June, confirming a continued slowdown.

The June trade data further suggests weaknesses in domestic demand and investment as import growth decelerated to 6.3% YoY in June from 12.7% YoY in May. The overall deceleration was largely led by commodity imports, where imports of eight major commodity categories for June, in terms of volume, have produced the worst results in a year.

The corporate sector’s profitability is also falling, with the current pace of profit growth the worst since the 2009 global financial crisis. The industrial sector’s profitability also saw its largest decline in May this year.

Strong mix of monetary, fiscal and regulatory policy tools

However China has clearly started to take more decisive actions to support growth in domestic demand to offset the impact from the global economic slowdown. On the monetary front, it has cut banks’ required reserve ratios (RRR) thrice since November 2011. It has also cut interest rates not once but twice, in less than a month. The last time China cut interest rate was in 2008. Inflation has also fallen fast towards 2010 lows, allowing for more monetary easing.

China has a strong mix of fiscal, monetary and regulatory policies to sustain growth to offset the impact from the global economic slowdown
China has a strong mix of fiscal, monetary and regulatory policies to sustain growth to offset the impact from the global economic slowdown

On the fiscal front, policymakers are speeding up the approvals for infrastructure projects, introducing tax incentives to buy energy-efficient home appliances, as well as lowering the tax rate on small companies. This is testament to Premier Wen’s commitment that the second half of the year would see the government step up efforts to increase policy effectiveness and foresight.

On the regulatory front, China has lowered barriers to foreign ownership of domestic stocks and bonds –one of the most significant relaxations of its strict capital controls in more than a decade.

Bottoming out, no hard landing

Signs have emerged that the easing measures are starting to work and will continue to filter through in the coming months. New bank lending is accelerating, signaling an improvement in economic growth, albeit with a short delay. There are also renewed signs of life in the housing market – home prices posted its first gain in 10 months and home sales posted its first gain in May this year. A recovery in the housing market will lend strength to the economy, as residential construction accounts for 10% of GDP.

Shanghai (in 1990, top picture) has gone through such a rapid economic transformation that in just 20 years, it grew into a vibrant city comparable to that of London and New York (in 2010, bottom picture)
Shanghai (in 1990, top picture) has gone through such a rapid economic transformation that in just 20 years, it grew into a vibrant city comparable to that of London and New York (in 2010, bottom picture)
Photo credit:
www.imgur.com

According to McKinsey Global Institute, China’s economic transformation resulting from urbanisation and industrialisation is happening at 100 times the scale of the first country in the world to urbanise – the United Kingdom (UK) – and at 10 times the speed.

As at end-2011, urban dwellers account for 51.27% of China’s population (or a total of 690.8 million people), making it a predominantly urban nation for the first time in Chinese civilization. In 1979, less that 19% lived in cities.

Following United Nations (UN) estimates, 190 million more people will live in cities by 2020, and almost 300 million more by 2030. Urbanisation has already contributed significantly to China’s economic growth, and it will remain as an important source of economic growth in the future.

One major benefit that urbanisation brings is the potential consumption power. With more migration into urban areas, there will be significant increases in the demand for infrastructures, properties and household products.

Morgan Stanley expects consumption to become a key driver of economic growth for China. By 2020, they expect Chinese consumption to be at two-thirds of the US level and account for 12% of the world’s total.

Raffles City Shanghai (Left) and Raffles City Chengdu (Right) in China
Raffles City Shanghai (Left) and Raffles City Chengdu (Right) in China

From the policymakers’ perspective, China is undertaking plans to rebalance its sources of economic growth towards a consumption-driven growth path. This is evident at the annual National People Congress held in March 2012, where Chinese Premier Wen Jiabao listed “expanding consumer demand” as his first priority.

The China Consumption Market Development Report published by the Ministry of Commerce think tank in March 2012 said domestic consumption will overtake investment as the biggest driver of growth in 2012. Based on recent GDP data, domestic consumption stood at 57.7% to GDP in the first half of this year, compared with 47.5% in the first half of last year, clearly overtaking investment as the main driver of growth for the first time in more than a decade.

Looking ahead

No economy can expand indefinitely at China’s historic double-digit rate. Premier Wen had said that what China hopes to achieve is a “higher-level and higher quality development over a longer period of time” even as the country contends with a slightly lower GDP growth rate. The focus is on the quality of, rather than the pace of growth.

A consensus is emerging that China’s growth is set to decline gradually as the economy enters a period of transition. The World Bank expects GDP growth to decline from an average of 8.5% in 2011-15 to around 5% in 2026-2030.

With reference to Angus Maddison, the author of The World Economy: A Millennial Perspective, an economy tends to decelerate after reaching a certain level of development. When GDP per capita for an economy reaches $7,000, average GDP growth rates over the following decade tend to decelerate significantly. China’s GDP per capita reached $7,000 in 2008. If history is a guide and the law of gravity applies to China, China’s economic growth is set to slow. But this slowdown would be intentional and carefully managed, as the economy transits from a path of growth at all cost towards a sustainable growth path.

Article is contributed by Christopher Wong, Manager of Economics Unit, CapitaLand Limited.

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