mercoledì 4 novembre 2009

China: a 2010 clouded in uncertainty

The latest economic data published in Asia have shown that the major economies of the region have emerged successfully from the crisis of recent years. Smaller countries such as the Philippines and Indonesia have completely avoided plunging into recession, Singapore emerged from the crisis in the second quarter, while South Korea’s GDP grew 2.9% in the third quarter of this year. India, thanks to increasing flows of direct investment, is likely to come as a positive surprise in the coming months. All this has resulted in an upward revision to IMF’s economic growth estimates for Asia both in 2009 and 2010. The Washington Institute now forecasts 2.8% and a 5.8% growth in Asia in 2009 and 2010 respectively against earlier estimates of 1.2% and 4.3%.

But investor attention remains focused on China’s economic growth. The recently published third quarter data has suggested that the worst may be behind for the Chinese economy. The most encouraging indication came from GDP, + 8.9% y/y in real terms from +7.9% y/y in the second quarter and +6.1% y/y in the first quarter. Indeed, it is commonly believed that the Chinese economy needs to grow around 9% a year not to record higher unemployment rates. Further signs of improvement came from industrial production, up 13.9% y/y in September, and exports, whose pace of decline slowed to 15.2% yoy from 23.4% in August. Retail sales should continue to move upward in the medium term (+15.5% y/y in September vs. +15.4% y/y in August), mainly driven by improved sales of cars (+44.5% y/y), furnishing (+34% y/y) and construction materials (30.2% y/y). A boost to private consumption (down from 67% in 1981 to 48% in 2007 as a percentage of GDP) to the detriment of exports was, in fact, considered key by most economists to help rebalance the Chinese economy when the crisis broke out.

However, many investors and economists fear that the ongoing recovery might not be due to the strength of the economy, as argued by Goldman Sachs economists, but only to the aggressive expansionary policy pursued by the Government and that 2010 may produce negative surprises.
In the face of last two years’ crisis, in fact, the Chinese government has implemented a USD586bn fiscal stimulus plan, mainly aimed at infrastructure construction, post-earthquake reconstruction and affordable housing building.
More importantly, major domestic banks and small regional banks have started easing credit standards following the directives enacted by the central government. In the first nine months of 2009, in fact, new loans amounted to 8670 billion yuan, compared with 3480 for the same period last year. Although new loans have began to slow in the second half of this year (from a monthly average of 1230 billion in the first half to 428 trillion in the first 3 months of the second quarter), loan growth remains significant, hence raising fears that the Chinese economy could soon begin to suffer from excessive indebtedness.

Chinese authorities are particularly concerned that a large share of these new loans were not used to underpin the real economy but to heighten speculation on financial and real estate markets, increasing the risk of new speculative bubbles. For example, China Business News, citing government sources, indicated that almost 20% of the new loans in the first six months of the year had been invested in the Shanghai stock market. New loans to the property market also rose sharply. According to the National Office of Statistics, house prices in 70 reference cities rose by 2.8% y/y in September, up from +2% y/y in August. The sharp improvement led Moody's upgrade its outlook for the Chinese residential market from negative to stable.
Considering also the higher-than-60% stock market rebound since the beginning of this year, the Chinese authorities appear to be ready to take action to prevent this trend from jeopardising the country’s financial stability.

The Commission for banking regulation will introduce new measures to ensure that the new loans are not used for purposes other than supporting the real economy. According to a draft reform published in the Commission's website, loans exceeding 300 thousand yuans (about 30 thousand Euros) would be paid directly to the counterparty. "This is the first step towards a removal of the expansionary policy and it was decided after the latest reassuring economic data" said Gabriel Gondard, Fortune SGAM Fund Management CIO in Shanghai to Bloomberg news agency. Nevertheless, market experts are divided over the Chinese authorities’ future economic incentives choices. For example, economists at UBS and Credit Suisse believe that reserves to be held at the Central Bank by commercial banks will be increased by the end of the year. By contrast, Stephen Roach, chairman of Morgan Stanley Asia, said that Chinese authorities aim to maintain social stability, which can be only guaranteed by sustained growth. A new economic downturn, a clear possibility in 2010 should the Government remove the fiscal stimulus, is, therefore, to avoid.
The trend of prices is another factor that helps maintain the ongoing expansionary policy in place. Despite the sharp increase in M2 money supply (+29% y/y in September), consumer prices (-0.8% y/y in September) are expected to edge up in 2010. Economists at Morgan Stanley, for example, see inflation averaging at 2.5% in 2010, with an upward pressure that should only come from a stronger-than-expected international recovery, which would push higher commodity prices. According to Morgan Stanley, the government will not raise rates ahead of any such move by the Fed, which is expected to start tightening in mid-2010, given the close relationship between the Dollar and the Yuan.
The Council of State has shown that a continuation of government stimuli would be necessary to rebalance the Chinese industrial sector, which is skewed towards given sectors. As a first step, the government decreased the number of financing projects for the production of aluminium, steel and cement to prevent excess capacity. The challenge facing the Chinese economy in 2010 will therefore be to sustain economic growth while avoiding over-indebtedness. This will be crucial not only for the country’s but also for the global economy. Should a rebalancing of the economy fail to materialize, a renewed focus on exports would be inevitable.

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