China's Economy in the Post-Crisis World

China's robust government finances, relatively strong and liquid banking system and considerable  institutional experience with formulating and implementing stimulus programs contributed to its quick and strong recovery from the global recession. Yet despite the country’s extraordinary recovery, pressing questions have emerged about China’s stimulus exit strategy, including concerns about property bubbles, strength of the banking system, and state of U.S.-China relations.

Carnegie hosted Tom Byrne, senior vice president and Asia-Middle East regional credit officer at Moody’s Investors Service, the Atlantic Council’s Albert Keidel, and Carnegie’s Pieter Bottelier to discuss the outlook for China’s economy. Carnegie’s Douglas Paal moderated the event.

Positive Financial Outlook

Byrne presented Moody’s sovereign and banking credit outlook for China:

• The sovereign credit rating outlook is positive, due to:
  • Very low vulnerability to external credit market and financial shocks.
  • High household and corporate savings, which can aid financial and macroeconomic stability.
  • Low government debt, which, at about 17 percent of GDP (compared to 40-50 percent in most emerging markets), can be financed at a reasonable interest rate.
  • Ample fiscal space to deal with domestic shocks. Furthermore, pragmatic and cautious policies have reduced systemic risks.
  
   
• The banking sector outlook is positive as well, a result of that fact that:
  • Most banks have high capital levels and non-performing loans are estimated to be less than two percent.
  • The banking system can withstand stress scenarios, such as annual GDP growth of less than 8 percent, which is attributed to the country's largest banks' solid earnings and loan-loss reserves.
  
   
• Factors such as maintenance of robust government finances, continued institutional strengthening, and macroeconomic stability would improve China’s credit fundamentals and would put upward pressure on the rating.

Can China Sustain its Growth?

Bottelier noted that its well designed and timely stimulus program has helped China climb out of the crisis quickly through a reliance on domestic demand. He attributed the success of the stimulus partly to the strengths of the fiscal situation and banking sector, which had undergone ten years of intensive reforms. Unless China makes some big policy mistakes or a second recession happens in the United States or Europe, Bottelier stated, the prospects for China in the near term future look good for a sustained high growth. However, some concerns remain:

• Domestic Investment: China’s recovery was heavily dependent on domestic investment growth, which accounted more than 90 percent of total growth last year.  This kind of domestic growth, which was catalyzed by government stimulus efforts is clearly not be sustainable, as the Chinese government realizes.
   
• Different GDPs: Keidel argued that statistics on China’s growth can be misleading. Their typical monthly and quarterly a year-on-year growth numbers smooth over fluctuations that can be seen if the change in GDP is calculated relative to the previous month or quarter, and adjusted for seasonal factors. For example, the estimates for seasonally adjusted quarter-on-quarter GDP growth in the fourth quarter of 2009 was only 6.7 percent, significantly lower than the year-on-year figure of 10.7 percent. Keidel emphasized that studying the change in GDP from the previous quarter can help determine if the Chinese economy is overheating and aid in making timely policy decisions.

Vulnerabilities

Panelists indicated that the Chinese economy might be vulnerable to both inflation and a rise in local government debt:

• Inflation: Bottelier noted that inflation in February was much higher than January, owing to food price increases caused by the cold winter and high consumption during the Chinese New Year. Keidel cautioned that unless the trade surplus stops its decline, overheating may not be a serious concern, as the effect of domestic demand is moderated by the decline in trade surplus. Nonetheless, Keidel suggested that the uptake in the seasonally adjusted monthly inflation rate is worth watching. Factors that might cause an increase in inflation include:
  
  
  • Overstimulation of domestic consumption.
  • The rise in producer price inflation, which could squeeze the profit margins of the manufacturing sector.
  • The bubble in the property sector. A recent public opinion poll showed that housing affordability is rated to be a top domestic problem.
  
   
• Local Government Debt: Although reliable official numbers are not available, private sources have estimated that local government debt may be as high as 30 percent of GDP. However, according to Bottelier, local government loans are backed by real assets and most of these projects, like toll roads and subways, are revenue generating. Byrne noted that risk management by local governments has improved over the years.

U.S.-China Relations

Panelists addressed the heightened concern about China’s exchange rate and agreed that there is no proof that China is intentionally manipulating its currency for unfair trade advantage. They also emphasized that China’s growth is not primarily driven by exports, but by domestic demand.

• Currency Manipulation: Keidel noted that he is unconvinced by assertions that China knowingly misused the market. There is no easy way to tell if a currency is undervalued or not. Bottelier agreed that it does not make sense to label China as a currency manipulator. After the Lehman collapse, both the dollar and the renminbi (RMB) appreciated. He also cautioned that trade flows were influenced by many factors other than nominal exchange rates and that calculations of under- or overvaluation had limited practical value.
   
• Trade Balance: China is serious about rebalancing its economy. Chinese growth has been primarily driven by domestic demand. Keidel mentioned that China’s trade surplus dropped by about 50 percent over the last six months of 2009, while Bottelier reminded the audience that, while China’s consumption to GDP ratio is indeed unusually low, it has the fastest growing large consumer market in the world, with private consumption growing by 7.5 percent over the last ten years, compared to 3.6 percent in the United States.
   
• Chinese Surplus and U.S. Deficit: According to Keidel, China’s growing surplus was not the cause of the widening U.S. trade deficit. China’s trade surplus had declined in real terms in the early 2000s when the U.S. deficit widened. Instead, the trade surplus in the rest of the world, due to U.S. macroeconomic policies and de-facto deregulation pushing up demand, matched perfectly with the widening U.S. deficits.

In his concluding remarks, Bottelier noted that the crisis has confirmed the Chinese in their belief that the state has to have a large role in the economy. Keidel added that the issue of China’s exchange rate should be addressed within the broader context of China’s global trade and its overall exchange-rate position, not just its trade and currency with the United States.