The Resurgence of Chinese Economic Growth
Western Asset
September 11, 2009
Introduction
The Chinese economy has undergone a V-shaped rebound in its growth trajectory in 2009. The latest GDP release for 2Q09 shows a sharp rebound expanding 7.9% year-on-year (YoY) compared to 6.1% in 1Q09. The Chinese government’s timely and aggressive stimulus policies put in place last year have been instrumental in reviving the economy. To recap, the government implemented a massive RMB4 trillion fiscal stimulus package late last year while the reserve requirement ratio and lending rates were slashed a respective 200 and 220 basis points (bps) in the aftermath of the Lehman Brothers collapse. In this paper we examine the role the central government has played in contributing to the reversal in the economic growth trajectory, the related implications and an overview of where the Chinese economy stands after the first half of 2009.
An Investment-Led Recovery
The fiscal stimulus package introduced by the government may have contributed largely to the sharp recovery, but is it consistent with achieving a more balanced economic growth model? Does the recovery lead to an equitable distribution of wealth and are new jobs sufficiently created?
The fixed-asset investments in China over the first half of 2009, driven primarily by the central government’s fiscal stimulus, contributed 88% to the impressive 7.1% rate of growth. Public spending is considered the most effective tool in the short term to stem the decline in economic activity and improve confidence. An unfortunate side effect of the stimulus, however, is that it may result in pushing the economy further from the goal of achieving balanced growth that relies more heavily on domestic consumption. Rebalancing the economy toward domestic demand, which currently accounts for approximately one-third of GDP, is likely a medium-term goal, as changing the high propensity to save will take time.
That said, the fiscal stimulus did include some broad-based contributions to the private sector. For instance, it included several measures that have helped boost private consumption, especially in rural areas. Apart from the more widely publicized tax incentives implemented to increase demand for automobiles, there have also been subsidy programs in rural areas to spur demand for household electronics, such as personal computers, televisions and water heaters. These subsidies have helped alleviate some of the decline in income arising from the layoffs of migrant workers in the coastal region.
The income gap in China has been an ongoing concern as the government seeks to maintain stability. Even given measures within the stimulus plan designed to counteract an increasing income gap, there is concern that the gap has widened on the tails of the economic rebound. Sharp recoveries in property and equity markets have directly benefited the haves, while the have-nots are still undermined by lack of income growth due to a high unemployment rate. The central government believes that an 8% growth rate is necessary to create jobs. The job-to-applicant ratio remained at 0.8:1.0 as of 1Q09, unchanged from 4Q08 when the economy was at its weakest point. The reading was at 1.0:1.0 in 2Q08 prior to the onset of the global financial crisis.
Local governments tend to favour infrastructure/heavy investment spending as it is often easy to implement and can yield quick results compared with the more labour-intensive service sector. This has not only resulted in the underdevelopment of the service sector, but has also further aggravated the problem of overcapacity in the heavy manufacturing sector. To mitigate potential declines in manufacturing job prospects, the central government is considering adding employment to the list of key performance indicators it uses to monitor local governments, in addition to the existing metrics of economic growth and tax revenue. This is also an attempt by the central government to incentivize local governments to invest in sectors that could create more jobs.
Curbing Speculation
Record bank loans and rising asset prices—are these problems in the making?
Part of the stimulus enacted by the central government included supporting the domestic banking sector. The aggressive loosening of bank credit policies saw a rapid increase of RMB7 trillion in new lending in 1H09, compared to RMB4.9 trillion extended for all of 2008. Although there have been concerns regarding the health of banks’ balance sheets arising from the rapid loan growth in 1Q09, loan-to-deposit ratios (LDRs) remained reasonable at 66.7% in 1H09 compared to an average of about 65% in 2008. LDRs did not increase more sharply due to strong deposit growth. Renminbi deposits increased 26.2% year-over-year in April, with corporate deposits growing by RMB737.5 billion and household deposits increasing by RMB111.7 billion.
Regulators have raised the stamp duty from 0.10% to 0.30% in an attempt to curb speculative activities in the property market that may have been the result of excess liquidity. Tighter mortgage lending policies have been introduced for second home mortgages following signs of excesses in residential properties in the first-tier cities. Given the important role the housing sector plays in the recovery of domestic demand, we find it unlikely that the central government would implement wide spread policies to suppress household demand for real estate. This is especially the case as we have not observed a wide-scale bubble in the property market. It seems that the wealthy Chinese are behind the strong uptick in property prices in Beijing and Shanghai. Property prices outside of these markets have hardly moved.
Considering that the Chinese government owns all the land in the country, the property market is considered an important macroeconomic policy tool. If the government is truly concerned about a bubble forming in the property sector, as per recent reports, it could easily mitigate such a trend by increasing land sales. Land sales are still happening but are very slow as most local governments are waiting for better prices to line their own coffers.
Interestingly, the commercial property sector may be experiencing excess supply as some buildings have zero occupancy. That said, any near-term price adjustments are expected to be limited as most of the empty buildings are owned by state-owned developers. These state-owned commercial developers are reportedly maintaining high prices rather than pricing to sell, similar to how local governments are treating the residential market.
Monetary Policy & Fiscal Position
Will China engage in monetary policy tightening to curb inflation in order to maintain stable economic growth?
The People’s Bank of China (PBoC) views risks of deflation and inflation as equally high but considers the consequences of deflation more difficult to manage than inflation. While there is no official target for inflation, the PBoC’s inflation tolerance level is usually set at 3% on the consumer price index. Its money supply target remains at 17%, though it has already exceeded the target by 10% this year as it has pumped liquidity into the system.
While it may be tempting to view recent measures (including resuming issuance of PBoC one-year T-bill a few weeks ago) as the first installments of policy tightening, we feel it is premature to view this as a reversal of Chinese policy-makers’ desire to maintain an accommodative policy stance. These measures should be viewed as a fine tuning to prevent overheating in the property and stock markets. In its latest quarterly report, the PBoC affirmed a “moderately loose” monetary policy and declared that supporting “stable and relative fast” economic growth remained its primary task.
The central bank has suggested that growth and external demand conditions must be on solid footing before explicit macro policy tightening measures can be enacted. Interestingly, the Chinese People’s Daily recently reported that State Council had criticized the PBoC for going too far in its recent fine tuning. There is a creeping sense that the central bank will stand pat for now until after the National People’s Congress proceedings in March of 2010.
Despite the recent fiscal stimulus, increased amount of new bonds issued by the Chinese central government and slower economic growth, China’s debt-to-GDP ratio remains one of the lowest in the world at 28% as of 30 June 2009, up from only 22% one year prior. The key risk continues to be local governments’ budgetary positions as deficit-to-GDP ratios at that level are in excess of 100% in many cases. Of course, it is not difficult to imagine that the central government would bail out these local governments if required.
Conclusion
What are the investment implications?
The rebound in China’s GDP in the second quarter of 2009 has led some to believe that China is ready to begin unwinding its fiscal and monetary stimuli. The fine tuning put in place by the central government, such as the issuance of one-year bills, has been cited as supporting evidence. However, we believe that the rebound in Chinese growth is still not on solid footing, particularly with external conditions still fragile. More progress needs to be made to achieve a greater balance of drivers of economic growth with less reliance on fixed-asset investments and exports and a greater emphasis on domestic consumption. In this vein, we believe that it is too early to assume that the Chinese central government will look to begin unwinding its monetary and fiscal stimuli. Rather, the government will seek to maintain ample liquidity while addressing possible threats to economic stability, such as asset price bubbles.
Source: Bloomberg, Chinese Academy of Social Sciences, JPM Research
Western Asset Management Company Limited is authorised and regulated by the Financial Services Authority. Western Asset Management Company Limitada is authorized and regulated by CVM – Comissão de Valores Mobiliários. Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services Licence 303160. Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services Licence for fund management and regulated by the Monetary Authority of Singapore. Western Asset Management Company Ltd is a registered financial instruments dealer whose business is investment advisory or agency business and investment management business with the registration number KLFB (FID) No. 427, and a member of JSIAA (membership number 011-01319).
Western Asset
September 11, 2009
The Chinese economy has undergone a V-shaped rebound in its growth trajectory in 2009. The latest GDP release for 2Q09 shows a sharp rebound expanding 7.9% year-on-year (YoY) compared to 6.1% in 1Q09. The Chinese government’s timely and aggressive stimulus policies put in place last year have been instrumental in reviving the economy. To recap, the government implemented a massive RMB4 trillion fiscal stimulus package late last year while the reserve requirement ratio and lending rates were slashed a respective 200 and 220 basis points (bps) in the aftermath of the Lehman Brothers collapse. In this paper we examine the role the central government has played in contributing to the reversal in the economic growth trajectory, the related implications and an overview of where the Chinese economy stands after the first half of 2009.
The fiscal stimulus package introduced by the government may have contributed largely to the sharp recovery, but is it consistent with achieving a more balanced economic growth model? Does the recovery lead to an equitable distribution of wealth and are new jobs sufficiently created?
Record bank loans and rising asset prices—are these problems in the making?
Will China engage in monetary policy tightening to curb inflation in order to maintain stable economic growth?
What are the investment implications?
© Western Asset Management Company 2012. This publication is the property of Western Asset Management Company and is intended for the sole use of its clients and their investment consultants. It should not be forwarded to any other person. Contents herein should be treated as confidential and proprietary information. This material may not be reproduced or used in any form or medium without express written permission.
Past investment results are not indicative of future investment results. This publication is for informational purposes only and reflects the current opinions of Western Asset Management Company and its affiliates ("Western Asset"). Information contained herein is believed to be accurate, but cannot be guaranteed. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change without notice. Statements in this material should not be considered investment advice. Employees and/or clients of Western Asset may have a position in the securities mentioned. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of residence. This material may not be used or reproduced in any form without express written permission. © 2012
Western Asset Management Company Limited is authorised and regulated by the Financial Services Authority. Western Asset Management Company Limitada is authorized and regulated by CVM – Comissão de Valores Mobiliários. Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services Licence 303160. Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services Licence for fund management and regulated by the Monetary Authority of Singapore. Western Asset Management Company Ltd is a registered financial instruments dealer whose business is investment advisory or agency business and investment management business with the registration number KLFB (FID) No. 427, and a member of JSIAA (membership number 011-01319).