Recovery with Chinese Characteristics

While China is not immune to the debt crises in the West, it is better positioned to cope with them.

Last Thursday, the People’s Bank of China lowered the benchmark deposit rates by 25 basis points and cut lending rates by 31 basis points; the second time in a month. The cuts fueled concerns that there is more trouble ahead for the Chinese economy.

There is a lot of noise in the markets and three macro trends complicate the picture. Economic conditions are deteriorating in Europe, the hoped-for recovery is slowing down in the United States, and China’s economy has been weaker than anticipated in early spring.

But what we may be witnessing now is a bottoming out in China.

Fiscal cliffs in the West, recovery in China

At the recent euro summit, the region bought time, yet again. Last Thursday, the European Central Bank cut its interest rate to a historic low of 0.75 percent, and its overnight deposit rate from 0.25 percent to zero. These measures will not have an energizing effect on the eurozone. Instead, they indicate that the ECB’s ammunitions are being exhausted.

In the US, job creation continues to slow, and unemployment remains at 8.2 percent. The number of unemployed Americans is 12.7 million and – if the temporarily unemployed are included – more than 23 million. Moreover, Washington has deferred critical economic decisions and a potential ‘fiscal cliff’ until after the 2012 elections.

No nation is immune to the paralysis of the transatlantic export markets, rising protectionism, and slowing global growth. In India, growth sank to 5.3 percent, the slowest in nine years.  During the first quarter of the year, China’s economy grew about 8.1 percent year-on-year, the worst quarterly growth rate in three years.

In April, the Chinese economic data fell short of market expectations. As a result, some investors became concerned that China would repeat the hard landing of 2008. In May, economic data was still weak, and the crisis in the eurozone entered a more dangerous phase.

However, the Chinese economy has been recovering since the government’s monetary loosening in fall 2011.

Instruments of ‘stimulus lite’ policies

In the West, China is perceived amid a worsening slowdown. Economists do not see a return to the kind of massive 4 trillion yuan ($630 billion) stimulus package launched in fall 2008. Yet, signs abound that the government is employing a “stimulus lite” policy. Some plans were initiated in February, but the soft data in April accelerated measures in several fronts.

The National Development and Reform Commission has accelerated the approval process for major infrastructure projects, including new airports and subways. The central bank of China cut the reserve requirement ratio by 50 basis points; it is likely to be cut twice before the year-end, starting soon.

As interest rate liberalization proceeds, a new rate cut cannot be excluded, if global prospects deteriorate significantly.

Fiscal policies are more proactive. The State Council has announced a 36.3 billion yuan subsidy program to encourage the consumption of energy-efficient household electronic appliances, automobiles, and power generators. The Ministry of Railways obtained large credit lines from banks in 2011, which will allow it to execute a planned investment of 400 billion yuan.

The Chongquing municipal government has signed multiple contracts with 30 major State-owned enterprises, which are expected to invest over 350 billion yuan in Chongqing in the next few years. This deal provides a blueprint for similar SOE-local government initiatives in the coming months.

Déjà vu all over again

Change is in the air, even if the markets have missed some of the signs.

Real GDP growth in China could rebound in the second half of the year, at about 8-8.4 percent year-on-year. Some key data remains soft, but there are signs of recovery in housing markets, exports, and lending.

Industrial production is picking up and a series of financial reforms are being introduced.

At the turn of 2008/9, the world economy was still suffering from a severe downturn. When Premier Wen Jiabao said that China could achieve 8.5 percent growth in 2009, few observers in the West took his view seriously. In fact, the Chinese economy was already rebounding.

Again, when Wen visited Wuhan in May, he said that the government was making stable economic growth an important priority.

In the past quarter, the government’s focus has moved from fighting inflation to stabilizing growth.

No room for complacency

However, there is nothing automatic about the rebound. It could erode, if further policy loosening is inadequate or too slow. As Premier Wen Jiabao said during the weekend, China’s economy is running at a generally stable pace, but the government should “preset and fine-tune its policies in a more aggressive manner”, while sticking to pro-active and prudent monetary policies.

Worldwide downside risks remain significant as the debt crises in the eurozone and the U.S. are likely to deteriorate in the coming months. In China, monetary easing should solidify the rebound.

According to the latest data, Chinese inflation fell more sharply than markets expected in June. Year-to-year CPI inflation slowed to 2.2 percent,  the lowest since January 2010, while PPI inflation turned sharply negative at -2.1 percent, the steepest disinflation in almost three years.

The decline in CPI inflation can be attributed to the weather-related impact on food prices, while the decline of transportation prices can be explained by price declines in energy markets. If anything, the disinflation trend leaves more room for policy easing in the latter half of 2012.

In effect, the “stimulus lite” initiatives are likely to support the rebound of inflation and property prices by the year-end. In that case, the window of policy loosening may prove relatively brief.

There is no room for complacency in the second half of 2012 and the beginning of 2013. China’s economy has strong long-term growth potential. But the eurozone and even the US are moving toward a dangerous winter chill.

 

Slightly modified from Dan Steinbock, “China’s economy is on a rebound,” Op-Ed, China Daily, July 9, 2012.