In Forbes online dated 27 November, Gordon Chang, of "The Coming Collapse of China" fame in 2001, flags up the fact that China Purchasing Managers’ Index for November dropped from 51.0 to 48.1, "crossing the crucial line of 50 that divides expansion from contraction. Most worrisome, it appears that the factory sector is shrinking due to weakness in domestic, as opposed to export, orders."
Chang highlights how indebted China's banking system has become, owing to huge hidden and often non-performing loans raised by local governments. He opines that notwithstanding China's massive reserve of $3.2 trillion, the People's Bank of China (PBOC), China's central bank, is virtually insolvent.
According to Chang, to stimulate the economy, interest rates cannot be cut further for fear of flight of savings. Nor can banks' capital rerserve requirements be lowered much for fear of inflation, which remains high. With housing prices collapsing, he wonders whether a renewed bout of pump-priming would work as investors are now fleeing the Chinese market. Click here
Much of what Gordon Chang says is true. Morever, China is extremely worried by the current global debt crisis, especially in Europe, which is China's largest market. A Eurozone Armagedden will erase many Chinese factories and jobs and will worsen China's many looming risks in an uncertain world.
China's inflation has come down significantly. It dropped to 5.5% in October, down from 6.1% in September, and a peak of 6.5% in July. This is against an economy which the IMF has recently estimated to grow at 9.5 percent this year, albeit slowing from 10.3% in 2010. Click here
China's slowing economy is a reflection of the slow-down in world markets but is also a result of China's changed strategy towards a slower and more sustainable and balanced growth. During the new Five Year Plan (2011-15), government policies and investments will focus on techological upgrading, innovation, creative industries, ecological conservation, new materials and new energies. In any case, 9.5% growth in the current global economic climate is a growth rate many countries would die for.
While China's exports have dropped, imports are growing and domestic consumption is surging ahead.
Anecdotal evidence suggests an exciting consumer market. KFC in China is opening 500 new restaurants a year. According to a Knight Frank Research report in November 2011, Banana Republic is tripling its stores from 15 to 45 in 2012. Gap has eight stores in Shanghai and Beijing and plans to open outlets in Hangzhou and Tianjin before the end of this year. China's fashion market is expected to triple to more than RMB1.3 trillion in the next ten years, driven by rising consumer affluence.
Per-capita spending among urban consumers is RMB1,150 per year. In terms of purchasing power parity, it translates into about US460, roughly 60% of the levels in Britain and the US. With an expanding urban population of some 665.57 million in China, the rising disposable income overall will generate a great deal of additional tax revenue, thereby strengthening the government's finances.
China's deposit interest rates have always been much lower than inflation, as a form of "financial repression" to channel such savings via the deposit-taking state-owned banks as cheap capital for the People's Bank of China (PBOC). In any case, low interest rates notwithstanding, to China's vast majoirty of conservative savers, bank deposites are regarded as the savest form of storing hard-earned nest eggs as other investment alternatives are much more limited and much less developed compared with Western economies. Rising disposable income will therefore greatly expand the PBOC's capital base.
To stimulate economic growth, there is thus room with exchange control for bank interest rates to be reduced without driving away depositers. As inflation has come down, bank reserve requirements, which have been increased nine times since September 2010, have also plenty of leeway for manoeurvre.
Naturally, despite foreign pressures, China is sticking to her principle of maintaining a stable and flexible exchange rate without being rushed into full convertibility on the captial account. China has learnt how useful such non-convertibility was against risk contagion during the global financial crisis. Such policy should continue to serve China well amidst the current European soverignty debt imbroglio. Indeed, the RMB is now being allowed to depreciate a little to ease the pressure on manufacturing.
It is true that local government debt, hidden behind so-called Local Government Financing Vehicles (LGFVs), remains a mounting threat. The official China Securities Journal reported on 15 August that about 26% of LGFV loans, some RMB 2.8 trillion, are considered fully backed with cash flows from projects. Overall loan levels are expected to peak in 2011 and 2012, during which period about 43% or RMB 4.6 trillion of these loans is expected to fall due.
In a recent article dated 1 September on Qiushi, the Communist Party of China (CPC) official website, Premier Wen Jiabao revealed that according to State Council investigations (March- May 2011) , the extent of LGFV loans amounted to 10.72 trillion yuan ($1.68 trillion) or 28% of GDP. Of these loans, 51.15% were for pre-2008 commitments, mostly infrastructural and economic projects, many of which are required to drive China's breathless urbanization across the country. The extent of such loans is large but is still considered manageable.
Since then, the Chinese government has applied stringent controls in regulating the use of LGFVs. As a result, credit growth has been reducing towards normalcy. China's M2 broad money supply rose 12.9% year-on-year to Rmb81.68 trillion at the end of October, according to the PBOC. The growth was slightly lower than the market expected 13% rise, and remains well within the 16% target range. Nevertheless, the speed of credit growth is still high as the State intends to provide more and better credit for agriculture and Small and Medium-sized Enterprises (SMEs). So the situation is being watched with vigilance.
On the robustness of China's banking sector, the IMF's Monetary and Capital Markets Department has just completed a Financial Sector Assessment Program stress tests of the largest 17 Chinese commercial banks, about 83 percent of the commercial banking system. In a report issued on 18 November, while warning against the threats posed by informal credit markets, conglomerate structures and off-balance sheet activities, the IMF noted the country's significant progress toward a more commercially oriented system and confirmed that most of the banks appear to be resilient to isolated shocks.
Dropping real estate prices are to be expected and indeed, according to plan by the Chinese government, as a result of a series of credit and adminstrative tightening measures to rein in a growing property bubble. The question is whether a drop of as much as 30% now and possibly more in future could precipate a massive clash. With generally low mortage gearing (about 60%) and huge pent-up demand from the marriageable and more affluent post-Reform generation, the current drop is no doubt painful but shows little sign of an imminent collapse.
Against a worsening global economic outlook, there are signs that China may resume a stimulus or pump-priming strategy. It worked for China during the global financial crisis when market conditions were at least no better than now. Such stimulus largely goes into meeting China's gargantuan infrastructural appetite to drive the country's rapid urbanization. There is no convincing reason why it won't work this time.
According to McKinsey Global Institute's report Preparing for China's Urban Billion (March 2008), almost 50% of China's GDP is driven by urban fixed investment over the past ten years with an annual expenditure of 6.4 trillion RMB in 2007. This is equivalent to $1trillion or about one-sixth of China's economy. By 2025, China aims to build 221 new cities each with a population of over one million, compared with 35 such cities existing in the whole of Europe. Click here for the McKinsey report
China's urbanization still has a very long way to go. According to the Five Year Plan 2011-15, urbanization is to increase from 47.5% to 51.5%. Because of its speed, many commentators will continue to warn of what appears to be a great deal of empty buildings and roads to nowhere. Well, many said the same about Shenzhen and Pudong before these vibrant mega-cities took shape in a matter of just a few decades.
At the end of the day, the implosion of the looming Euro crisis will not be the be-all-and-end-all for China. China-Europe trade amounts to $3.112 trillion, or 16% of China's total trade. It has been estimated that a one-pecentage fall of Europe's GDP is likely to reduce China's GDP by 0.18%. Even a European melt-down, therefore, is unlikely to spell the end of the world for China.
Finally, on 30 November, Standard and Poor’s down-graded the long-term credit grades of some of the world’s largest banks, including Bank of America, Goldman Sachs, Citigroup, Morgan Stanley, JPMorgan Chase, along with Barclays, HSBC, and others in Germany and France. The rating agency, however, upgraded Bank of China and China Construction Bank while maintaining the A rating on Industrial & Commercial Bank of China (now the world’s largest bank by market capitalization). All three Chinese lenders are given higher grades than most big U.S. banks. This fact speaks for itself. China's biggest banks are not without problems, but they are relatively healthier than some people may think.
Since forecasting in 2001 "The Coming Collapse of China", Gordon Chang has not changed much his continuing story of China's Doom. His research is well respected but needs to be put into a more balanced perspective.
Best regards,
Andrew
