My Blog

January 24, 2008

There were plenty of new numbers today to think about in trying to understand what is happening in the Chinese economy.  While lots of different analysts are putting different spins on these numbers, I have to say that the latest batch of numbers has done nothing to allay any of my worries about the overheating economy and the consequences of Chinese monetary policy.  For all the government attempts to moderate the economy and the possible benign effects of a US slowdown, Chinese growth is still out of control.  Unfortunately I am afraid that the blunt measures needed to rein it in run the risk of slowing it down much faster than anyone is comfortable with.  China is stuck between excesses.

According to today’s release by the National Bureau of Statistics, China’s GDP for 2007 was RMB 24.6 trillion ($3.4 trillion at today’s record high exchange rate of RMB 7.235 to the dollar), up 11.4% from last year.  This is the fastest pace of growth in 13 years, although growth in the 4th quarter was “only” 11.2%, down from the 2nd quarter’s high of 11.9%.  I know a lot of analysts are reading good things into the slowdown, hoping that it represents evidence of moderation, but a little perspective is in order.  From its anomalous 2nd quarter peak to its 4th quarter trough, the pace of growth has declined by less than 6%, and by any measure even 4th quarter growth is extraordinarily high, substantially exceeding the eye-popping average for the past five years of 10.6%.  Make no mistake – we are still in the cocaine-fueled stage of crazy growth and the question is mainly whether there’s enough cocaine, in the form of monetary expansion, left to keep this party going.

CPI inflation came in at 6.5% for December – the high side of the expected range.  This is less than November’s 6.9% CPI inflation rate, but as several commentators have already pointed out, because of last December’s high base this is at least equivalent to November’s rate (and Credit Suisse says it is actually much higher, by 0.5%, than November’s rate).  Clearly there has been no disinflation.  As I have written many times, I suspect that because of the upcoming holidays the government may have helped ease prices down via price controls and the selling of food and coal reserves, which means that recent inflation, high as it is, is artificially low, and we may see upward pressure on prices in March.

PPI numbers are not much better, and the trend there is worse.  PPI inflation was 5.4% in December, up from 4.6% in November, 3.2% in October, and 2.7% in September.  According to today’s release by the National Bureau of Statistics, the purchaser’s prices for raw materials, fuels and power went up by 8.1% in December, suggesting that inflation affects a lot more than just food prices.

Fixed asset investment grew by 24.8% for the year, to RMB 13.7 trillion, roughly equal to 56% of 2007 GDP and slightly higher than the growth in 2006 (23.9%), with investment in the booming (and overheated) real estate sector up 30.2% in 2007, compared to 21.8% in 2006.  This real-estate surge does not bode well for the banking sector because a big slice of their loans (and, I suspect a bigger slice of their future non-performing loans) are real-estate-related.  There has been a sharp improvement here in the sense that December’s increase in FAI, 19.3%, was much lower than November’s 26.1% and October’s 30.6%.  These numbers I got from Credit Suisse, who reads this decline as very positive and indicative of a soft landing.  I still see these numbers as too high, and given the lag between investment and production, indicative of trouble ahead if we do see a slowdown in global demand.

Industrial output is up 18.5% for the year – nearly two percentage points higher than 2006’s 16.6%.  It has declined over the year – it was up 17.4% in December, a little higher than November’s 17.3%.

So is China slowing down?  A little, but no, not really – some of the numbers are merely a little less outlandish than they had been.  Will it slow down as the PBoC raises interest rates, increases minimum reserve requirements, and enforces loan caps?  Probably not.  Today’s Financial Times points out that so far $9 billion have already been raised in the A-share market in 2008 and another $30 billion is expected to be issued in the next few weeks. 

At this rate new share issues should blow out the $78 billion raised in 2007.  When you toss in the fact that well over half of Chinese investment (I want to say 60% but please don’t quote me) has been funded by internally generated cash (corporate profits grew by 37% in 2007), and that there is anecdotal evidence that informal funding systems are growing, it is hard to see how a cap on loan growth, even if it is seriously enforced, will have much impact on reducing overinvestment.  The only real impact – admittedly an important one – is likely to be on real estate development, which is a serious problem here.  In the end the only policy that will slow down monetary growth is a much faster appreciation of the RMB, but even that will backfire in the short term as it causes a surge in hot money inflows (and of course the Fed’s recent cut doesn’t help).

What about a US slowdown – will that help moderate Chinese growth?  I am not able to handicap the probability, severity, or duration of a slowdown in the US economy, but I have never put much faith in the decoupling story and I suspect that a US slowdown will bring Chinese export growth down, perhaps even sharply. 

Its impact on the underlying economy, however, will come with a dangerous lag.  This is because a decline in exports will not immediately impact the trade surplus enough – a concomitant drop in consumption and in imported products for re-exports will mean that the trade surplus will remain extremely high, even if it declines substantially from the string of record monthly surpluses in 2007.  When the capital inflow consequence of this high trade surplus is added to hot money inflows, Chinese monetary growth will remain extremely high, and with it fixed asset investment and industrial production growth.  Chinese producers may find themselves caught in the vise of rising production and declining demand.

Comments (6) for "China's latest batch of numb...

Macroeconomic controls shouldn't be considered in isolation. The State Council has issued guidelines on the fraction of profits companies need to pay the state in the form of dividends, and that should markedly reduce the cash available for investment. Also the Chinese government still hasn't pushed the "emergency stop" button and just issue "macroeconomic adjustment" orders to state owned enterprises to stop investment. By Twofish - 1/23/2008 10:30 PM

I wonder where the dividend to state go. Will this flow out as added government expenditure, or reduction in loan demand by the government, or to other state owned enterprise as investment ? The only way this will not flow back to the economy is under a mattress. By Bill - 1/24/2008 12:03 AM

Added to this note of concern is the government's stated goal of increasing employment y roughly 10 million jobs this year. That certainly doesn't imply a willingness to make tough choices on investment or fiscal stimulus. By Paul Neureiter - 1/24/2008 12:38 AM

Twofish, the dividends range from 0 to 10%, but are mostly at 5% or under. Unfortunately using dividends for fiscal policy is very pro-cyclical -- there are plenty of dividends when you don't need them and not a whole lot when you do. As for pushing the "emergency stop" button, that is, I think, part of the problem. There aren't many intermediate steps left for policymakers and all the efforts over the past three years to moderate investment, growth and the trade surplus have only been accompanied by acceleration in all three. I worry that this machine only has two modes -- breakneck and stalled. We'll see if we do get a soft landing in which all the key factors moderate. Bill, I guess there isn't any way of isolating or segregating the flows, but higher dividends should mean lower debt for the government, unless of course the existence of the revenues spurs additional spending. Paul, I think this is one of the big dilemmas facing the government. What is more important, keeping the country from overheating (a rather abstract notion) or keeping unemployment down (a very blunt and easy-to-uderstand issue)? By Michael Pettis - 1/24/2008 12:59 PM

there is no question the growth is slipping, be it export, Non-residential investment and consumption. With property clearly peaking, export weaknening fast, it will be only a few quarters before we see 9 handle in GDP growth , overheating is largely past. The risk is in inflation, which accelerating closer to 10% despite 1 quarter of Rmb rise at 15% annualized pace, six rate hikes and price control. Stagflation is seriously risk in 2008, it wil put macro management between rock and hard places. Hopefully, MOF will help China spending out of it. US$150b fiscal stimulus might not save US from recession, similar fiscal gun powdery on consumption, infrastructure in next three year should sustain China growth above 8% By isaac - 1/24/2008 4:36 PM

The important thing about the dividends is that this is the first time that the PRC government has asked for dividends from the state owned enterprises. This is in part because this is the first time that SOE's are making profits. I think that in the PRC dividends are likely to be anti-cyclic. When the economy is booming, corporate profits are high, and having the state take dividends from the SOE's and do something like buy back borrowing creates a Keynesian cooling of the economy. When the economy is in a down cycle, dividends are smaller which leaves more money for the SOE's to invest. Dividends are likely to play a different role in the PRC economy than in other economies for two reasons. Dividends in the PRC are going to mostly to the state, which means that they are basically a form of taxation. The second unique feature of the PRC economy is that most investment spending doesn't go through the banks, but rather through invested reserves from the state owned enterprises. Hence, dividend policy is likely to be more effective than interest rate changes. In fact, one possibility is that interest rates in China might work the reverse than they do in the West. Most companies in the West are consumers of capital. When interest rates increase companies borrow less and so the economy slows. In China, enterprises have large cash reserves so when interest rates increase, this provides more return to the companies which allows them to spend more. For households, the possibility exists that interest rates are a Giffen good. When interest rates decrease, households save *more* in order so that they can spend more on funding social welfare and pension needs. So when interest rates increase, households save *less* so sense they have more money available. This would nicely explain why interest rates increases in China don't cool the economy and why other tools like dividends, reserve rates, and forced sterilization are necessary. By Twofish - 1/27/2008 2:59 PM