This post is a guest contribution by Nouriel Roubini*, RGE Monitor.
Today we take a closer look at the economic outlook for China, a preview of our global economic outlook which will be made available to advisory level clients in the coming weeks. China, the world's second largest economy by purchasing power parity, contributed over 10% to global economic output in 2007 and 2008 and is thus a key part of any recovery of the global economy.
As Nouriel Roubini notes in a recent report following a mid-March trip to China (available to RGE Monitor’s Premium Subscribers), it is clear that China faced a severe deceleration of growth in H2 2008 based on a number of indicators: GDP which was close to zero on a q/q basis, industrial production, production of electricity, PMI, weakness of auto sales, fall in residential home sales, manufacturing data, falling imports and exports. In fact, calculated on a q/q basis like most other countries, Chinese growth (which is reported only on a year on year basis) was practically zero and even negative by some private sector estimates.
However, there are greater signs of economic recovery in March from the depths of Q4 2008 and most forward looking indicators suggest that Q2 2009 through Q4 2009 growth will accelerate relative to the dismal Q4 of 2008 and weak Q1 of 2009. In particular, economic data for China (including loan growth, the PMI, recovery in residential sales volume – if not prices, and public investment) do point to a stabilization or even slight improvement but we at RGE Monitor still see risks that Chinese growth will be well below the government target of 8% and even below the 6.5% level that the IMF and World Bank are predicting – a figure of 5-6% seems more likely. The more optimistic outlook for Chinese growth would require a recovery in the global economy, especially the U.S. in the second half of 2009, a development that seems more likely to come in 2010. It seems too soon to point to an economic recovery, particularly in the absence of a rebound in demand from the G3 economies (U.S., EU and Japan) which absorb most of Chinese exports.
There are other risks to this scenario. First, the Chinese policy stimulus could turn out to be insufficient and further stimulus could be delayed. Second if a drugged recovery – via easy money, loose fiscal policy and easy credit – leads to further over-capacity (of which there is some evidence), it could result in rising non-performing loans, falling profits or rising losses.
Given the collapse of external demand, the exports are now in free fall while the policies that will eventually lead to greater consumption have been woefully slow to be implemented. The job of lifting domestic demand is mostly in the hands of an aggressive (“pro-active” in their term) fiscal policy and a more easy (“moderately easy” in their terms) monetary and credit policy. Although government-linked investment rose sharply beginning in February 2009, private sector capital expenditure (mostly financed via retained earnings) is likely to stay weak in 2009 given sharp profit declines. Furthermore, although indicators of private consumption like retail sales have remained relatively robust, they are growing at a slower pace compared to H2 2008. The extent of job losses and falling incomes as well as negative consumer confidence may slow consumption further going forward, particularly in urban areas, despite government incentives.
Despite the fact that China’s aggressive policy response included monetary easing, scaling up of bank lending and a particularly aggressive scaling up of government investment to offset the contraction in private demand, there is an increased risk that China will grow only in the 5-6% range year on year in 2009, about half its average growth of the previous five years, and well below potential. Such a growth rate would increase pressures on China's government as the hard landing has been accompanied by job losses and factory closures as well as implying that Chinese commodity demand could continue to be lower than recent trends.
There are signs that the government is increasingly front-loading its investment and backstopping bond issuances of cash-strapped regional and local governments who are being expected to provide their own contributions. And although implementation has been slow, the government has tweaked its spending to increase that allocated to social welfare programs. China is also taking the time to allocate spending to meet longer term goals including increasing the share of renewable fuels in its energy mix. However, the finance ministry's implicit 3% of GDP bound for its fiscal deficit mean that revenue shortfalls might limit additional spending should it be needed in 2010. Nonetheless, China’s domestic savings, its low debt, and the fact that it is still attracting FDI, albeit at a slower pace than 2008, imply that it is better positioned than many of its EM peers, in part because it can raise funds domestically to finance its deficits.
The structural reasons for high Chinese savings rates still persist. And with the Chinese yuan having returned to its implicit peg to the U.S. dollar, Chinese reserve accumulation and purchase of U.S. assets could again be quite strong in 2009. However, lower net hot money inflows could contribute to keep the pace of reserve accumulation below the one displayed in 2008.
But the gap between a very weak U.S. and global economy and the Chinese growth target of 8% for 2009 is wide and given the sluggish outlook for the U.S. and global economy, China may continue to grow below potential in 2010. There is also another important caveat: even once the U.S. economy recovers, it will rely less on consumption and imports and more on an improvement in net exports. The world where the U.S. was the consumer of first and last resort – spending more than its income and running ever larger current account deficit – and where China was the producer of first and last resort – spending less than its income and running ever larger current account surpluses – is changing.
*Nouriel Roubini is Professor of Economics at the Stern School of Business at NYU and Chairman of RGE Monitor.
