Editor’s Note: The following analysis has been revised from its original version to reflect the release of significant economic data in China on January 21, 2010.
It is clear from many indicators that economic recovery in China has continued to broaden and deepen, but risks are multiplying. China’s stimulus program worked better than even optimists expected. To reduce risks associated with property bubbles and rising inflation, however, China embarked on an exit strategy from its credit-driven stimulus program in January 2010—sooner than expected. Government confidence in its ability to manage the recovery is supported by the fact that, along with output, employment, and consumption growth, consumer expectations and general business conditions have improved continuously since the middle of 2009. Assuming that government policies effectively reduce domestic risks and that international conditions affecting China do not deteriorate, prospects for continued high growth in 2010 are good.
Growth and Trade
GDP grew 8.7 percent in 2009, well above the original target of 8 percent. Fourth quarter growth was 10.7 percent y/y, or about 11.0 percent q/q (seasonally adjusted and annualized). Third quarter growth was revised upward from 8.9 percent to 9.1 percent.
In addition to the broadening and deepening domestic economic recovery, external demand returned recently as a factor contributing to growth. December exports increased almost 18 percent (y/y) after 13 consecutive months of negative (y/y) growth. If this trend continues, China’s excessive dependence on domestic investment for growth during the initial recovery—more than 90 percent during the first three quarters of 2009!—will rapidly diminish, and a more sustainable growth pattern may emerge in the second half of 2010.
China has also significantly contributed to global economic recovery. In 2009, its trade surplus narrowed by about one-third (to $196 billion), and its contribution to global economic growth was about 50 percent. If there are no serious domestic stumbles and growth in the major OECD countries remains subdued, as expected, China’s contribution to global growth in 2010 will again be disproportionately large.1
China’s phenomenal stimulus program has not only restored domestic economic momentum, but is also contributing to a reduction in global, as well as domestic, economic imbalances—at least so far. The stimulus program was used to promote domestic consumption growth, increase and improve infrastructure and employment, especially in less-developed central and western provinces, promote tighter economic relations between the Chinese Mainland, Taiwan, and Hong Kong, and boost central government spending on social services.2 A large proportion of bank lending in 2009 (RMB 9.6 trillion) went to consumers (mainly for the financing of housing and consumer durables). Much of the rest was allocated to construction companies owned by local governments. The government worked to limit the amount of stimulus credit allocated to manufacturing industries plagued by excess capacity.
The main domestic economic risks confronting China seem to be further increases in inflation and bursting asset price bubbles.
There is, of course, no guarantee that China’s economy will continue to improve and that domestic and international economic imbalances will be further reduced. The short term macroeconomic management challenges that China faces are unusual and daunting; policy mistakes cannot be ruled out. Inflation may become a more serious problem and China’s external trade surplus may start growing again, like America’s deficit has in recent months.
Risks
The main domestic economic risks confronting China at this time seem to be further increases in inflation, especially producer price inflation, and bursting asset price bubbles.
Raw material and other input prices for producers are rising much faster than consumer prices. This could lead to significant margin squeeze for many manufacturing enterprises, depressing profits and business confidence.
Because of China’s enormous monetary expansion in 2009 and the excess liquidity that was thus created,3 consumer price inflation is potentially worrying as well, but the current situation is no cause for alarm. The relatively mild increases in November and December (0.6 and 1.9 percent y/y, respectively—the first positive consumer price index (CPI) numbers in nine months) were principally due to seasonal food price increases. Headline CPI inflation may well rise to 4–5 percent in 2010 but, this is unlikely to derail economic recovery and a gradual “normalization” of China’s growth pattern. The current consensus forecast for CPI inflation in 2010 is a relatively modest 3.5 percent because significant excess capacity still exists in many parts of the manufacturing sector and because the government is aware of the problem and has begun to tighten monetary policy.
Asset price inflation is at this point a greater worry than either producer or consumer price inflation. The national urban housing price index rose (only) 7.8 percent in 2009 and remains well below the December 2007 peak. However, the picture is very different for high-end residential property markets in major cities, such as Beijing and Shanghai. In those cities, premium apartment prices have been rising very steeply since March 2009—some describe the market as “manic”—and are now in bubble territory.
Anecdotal evidence suggests that the average purchase price in preferred parts of Beijing has reached around RMB 20,000 per square meter (about ten times the level of ten years ago), but properties selling for RMB 200,000 per square meter (about $3 million for a modest 100 square meter apartment!) are apparently going briskly as well. High vacancy ratios, combined with the fact that rental prices have lagged far behind sales prices, suggests that a lot of high-end apartment buying in major cities is speculative, fueled by excess liquidity created in 2009.
Share prices have also risen sharply in 2009 (the Shanghai Composite Index rose about 80 percent), but have recently fallen somewhat and remain well below October 2007 peaks. Besides, because of the difference between the source of finance used for shares and that used for real estate, the risk of financial instability associated with a possible collapse in share prices in China is much lower than the risk associated with one in real estate values. Although things may be changing, most shares are believed to be bought with own money. Margin buying of shares is at this point still illegal in China.4 Mortgage-financed real estate buying, however, has grown common since urban housing in China was massively privatized after 1998.
Because of a lack of data, it is difficult to ascertain the risk of financial instability associated with a possible collapse of housing prices. The risks are probably concentrated at the high end of the residential property market in selected cities and in the construction loan sector. At the low end of the market, there is a pervasive supply shortage; a bubble is not in sight. The national average urban housing price index is not in bubble territory and the average loan-value ratio for urban housing in China remains modest by international standards—even after the veritable explosion in mortgage lending during 2009. But reliable information is hard to find.5 Many home sales continue to be cash transactions. Even less is known about the loan-value ratio at the high end of the market, where the risk of a sudden downturn is much greater. The loan-value ratio for residential construction loans to developers is reported to be high in China—over 80 percent.
The government, concerned about associated financial stability risks, has recently introduced more restrictive conditions for second mortgages and tightened monetary policy. A mini banking crisis is possible, but, since the government is keenly aware of the risks and majority owner of all major banks, a burst property bubble is unlikely to destabilize the entire financial system as it did in the United States in 2008.
Lending and Monetary Policy
After many speeches about and high-level government commitments to maintaining moderately loose monetary policy in 2010, Beijing has suddenly begun to tighten monetary policy in recent weeks. Interest rates on central bank bills of different maturity and minimum reserve requirements for commercial banks were increased twice in January. In addition, direct instructions were given to banks to stop or limit new lending.
The government’s apparently increased inflation concerns may have been sparked by an unexpectedly sharp, and so far unexplained, expansion of bank lending (at least RMB1.1 trillion, about $160 billion) during the first two weeks of January.6 Reduced targets for loan growth (RMB 7.6 trillion) and M2 growth (18 percent) in 2010 had already been announced in December 2009.
Evidently, China did not want to wait any longer for the United States to take the lead in embarking on an exit strategy, as had undoubtedly been the government’s preference. More tightening measures are expected in the weeks and months ahead. Whether such measures will be supplemented by a flexibilization of China’s exchange rate policy—which is a global as well as a Chinese concern—remains to be seen.
Pieter Bottelier, former chief of the World Bank’s resident mission in Beijing, is a Nonresident Scholar in Carnegie’s International Economics Program and Senior Adjunct Professor of China Studies at the School of Advanced International Studies (SAIS) at Johns Hopkins University.
1 "Disproportionally” in relation to China’s share in global GPD measured at market exchange rates, which was about 7.5 percent in 2009.
2 Expenditures for health care in 2009 are provisionally estimated to have increased by 48 percent (over 2008) and for education by 25 percent. Government-sponsored social security provisions were improved and expanded, especially in rural areas.
3 M2 growth was no less than 30 percent in 2009, a multiple of estimated nominal GDP growth of 6.5 percent. This means that there has been a significant built-up of liquidity in the economy in 2009. The central bank’s target for M2 growth in 2010 is 18 percent.
4 The government announced on 8 January 2010 that it had authorized a trial period for buying shares on margin, short selling and stock index futures. Regulatory details have not yet been issued.
5 Industry sources quote an average loan-value ratio for residential urban properties of only 40-45 percent at end of 2008.
6 To put this in perspective, the expansion of bank lending during the last 2 months of 2009 together was RMB670 billion (about $98 billion) and the announced target for new lending during the whole of 2010 is RMB7.6 trillion.
