China’s Economy in the Post-Crisis World

Carnegie Endowment for International PeaceWashington DC, 17 March, 2010

Pieter Bottelier

Main points1. China’s stimulus program is huge and has been very

effective.2. Since March 2009 output-, employment- and

confidence indicators have continuously improved. 3. But problems have arisen: inflation, property

bubbles, housing affordability, trade tensions.4. The government recently embarked on a cautious

exit strategy from credit-driven stimulus program.5. Barring major policy mistakes and assuming no

second dip in US,EU, near-term growth prospects are good.

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Main objectives of stimulus program

1. Quickly revive employment and stimulate domestic demand (to compensate for falling exports) through:

- massive consumer loan- and subsidy programs - infrastructure investment, especially in less-developed

provinces - revival of urban real estate markets

2. Reduce China’s dependence on consumer markets in the West by:

- promoting South-South trade and investment - tightening economic relations between the Mainland, Taiwan &

HK - promoting internationalization of the RMB

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Quarterly GDP growth y/y & q/q

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What explains the success of China’s stimulus program so far?

• The program was well designed, initiated only 6 weeks after Lehman’s collapse and generously funded, especially with bank credit.

• China was not overleveraged like the U.S. Stimulus money immediately translated into incremental aggregate demand.

• Governments at all levels had relevant experience, and the country’s fiscal position was strong.

• Central and local government interests were fully aligned.

• After 10 years of intensive reform, China’s commercial banks were in good condition and had ample liquidity.

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China’s stimulus-driven growth pattern is obviously not sustainable

• M2 and credit expansion in 2009 over 30%!• Investment accounted for 8 ppts out of 8.7%

GDP growth in 2009. • Domestic demand in 2009 grew 12.3%! (i.e.

8.7% plus 3.6% negative contribution of net-exports).

Note: unsustainability is in the nature of stimulus programs.

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The stimulus program was mainly debt-financed

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The allocation of stimulus funds is not yet known, but a rough guess is: (source: Bottelier)

• Infrastructure : 50%• Low-cost housing and other real estate: 20%• Corporate investment and working capital: 9%• Consumer loans and -subsidies: 10%• Additional spending for social sectors: 7% • Tax reductions and other: 4% Note: Government tried to avoid channeling

significant additional resources to industries already in excess capacity.

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Is China is getting over-leveraged?

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Downside risks– Rising consumer price inflation, 2.7% in February y/y.– Rising producer price inflation, 5.4% in February y/y.– Rising wages due to labor shortages!– High leverage in the construction sector.– (Leverage in the household sector is rising, but still

low; average mortgage loan/value ratio under 50%).– NPL growth in the years ahead.– International trade protectionism .– Sino-US tensions over Taiwan arms sales and other

issues.– Reduced international business confidence (although

FDI is still increasing). 10

Share prices rose fast in 2009, but are not in bubble territory

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Uncertainty about local government debt

• Borrowing by local government-owned construction companies (investment groups) is not recorded as public debt.

• Total de-facto local government debt could be as high as 30% of GDP (Victor Shih).

But mitigating factors are:1. Loans are backed by real assets (usually land);2. Many projects are revenue-earning;3. Assets and liabilities all within the public

sector.12

Uncertainty about the extent of urban property price increases

• High-end residential markets in bubble territory, but full extent of problem is not clear

• Commercial property prices have peaked; is it true that this is not causing problems for banks?

• Head of NBS admitted to NPC delegates that house price index for 70 major cities may be faulty.

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This is the chart that NPC delegates did not believe – according to poll, housing affordability has sharply declined and is top public concern

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China’s trade surplus in 2009 reduced by one-third – to $196 billion. Not clear what lies ahead.

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Is China serious about rebalancing its growth model?

• Yes, but it will take years and require additional policy changes, including exchange rate and interest rate action.

• The national savings rate (50% in 2008!) will have to come down.

• Since 1999 too much investment went into manufacturing; this contributed to China’s large trade surplus and excess capacity problem.

• The government is trying to reduce Coast-Interior imbalances by concentrating infrastructure investment in less developed provinces.

• Income inequality and wealth gaps will probably continue to widen for some time. 16

The problem does not lie in slow consumption growth, which is perhaps the highest in the world

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In 2009 private consumption and total consumption grew faster than GDP

• Central government spending on social sectors increased sharply (e.g. health +48% and education +28%).

• Private consumption also grew fast (probably over 9%), but may slow when subsidies and loan programs are throttled back.

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International experience suggests that a county’s consumption/GDP ratio begins to rise when per capita income reaches about $9,000 (in PPP) – China is close

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Concluding thoughts• The U.S. has ceased to be a model for China’s

economic reforms – this has both economic and political consequences.

• The crisis has confirmed the government’s belief that the state should have a major role in the economy.

• China is trying to reduce dependence on Western consumer markets.

• China will reduce economic imbalances, but slowly.

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