China’s Economy Is Slowing, But…

English: GDP per capita of china provinces in 2009

English: GDP per capita of china provinces in 2009 (Photo credit: Wikipedia)

With a dismal May jobs report in the United States, analysts are looking at the fiscal turmoil in Europe and a slowdown in China and seeing little signs of hope.

There is little question that growth in China is slowing. The Chinese economy grew at 10.4 percent in 2010; 9.2 percent in 2011; and consensus estimates are that it will grow by 8.0 to 8.5 percent in 2012. However, there are three important factors that make China’s slowdown markedly different than those in other parts of the world.

First, China’s slowdown is self-induced and is not the result of external factors. Second, China has a full arsenal of monetary, fiscal and administrative tools that it can use to stimulate its economy, if and when it decides that stimulus is needed. Third, China is in the process of transitioning away from an economy that is dependent on government spending and exports to a more sustainable model where private consumption and investment are the key drivers.

China’s Slowdown is Self-Induced: The story of the 2012 slowdown in China’s economy began in 2007 when the country grew at 14.2 percent and the government concluded that such overheated growth was unsustainable. By shelving planned infrastructure projects, followed by credit tightening measures, the government began the process of guiding growth lower throughout 2008.

No one, of course, could have predicted the global economic crisis that ravaged every economy in the world, including China’s, and caused China’s leaders to reverse course. Infrastructure projects were taken off the shelf and put back into the system as part of the stimulus program that China announced in October, 2008, and the much needed fiscal stimulus was followed by credit loosening in early 2009. As a result of these measures, China survived the global economic crisis as its growth rate recovered from a low of 6.8 percent in 2008’s final quarter, to 9.2 percent for the full year of 2009.

Greater availability of loans, however, touched off a property boom. Investment in residential real estate increased 36 percent year-on-year by April 2010 and prices for residential properties skyrocketed. In response, China began tightening credit in the spring of 2010; stepped up credit tightening measures in 2011. It also added administrative measures in early 2011 that restricted purchases of residential property in 43 cities across China. Such housing restrictions included limits on the number of units that households could buy, curbs on purchases by non-residents of certain cities, higher deposit requirements for homebuyers, and caps on the prices that developers could charge for apartments. These tough measures are the reasons why year-on-year growth in investment in residential real estate plummeted to 4 percent by April of this year.

Besides fears of a property bubble, another vexing problem that China faced in 2011 was inflation, which began rising toward the end of 2010 and kept increasing before peaking at 6.5 percent last July. Last year’s inflation was particularly troublesome because 40 percent or more was related to rising food prices, greatly impacting those in China the least able to afford higher prices in such a large part of their budget.

In addition to credit tightening measures, China clamped down on infrastructure spending to cool inflationary pressures. From 2005 to 2011, infrastructure spending grew by an average of 22 percent per annum, including 40 percent growth in the stimulus year of 2009. In 2011, the government reduced growth in infrastructure spending to 10 percent, with year-on year growth in December of last year falling to a mere 2 percent.

China Has a Full Tool Kit: While China began easing credit in late 2011, and expectations are that the 2011 housing restrictions will be lifted and infrastructure spending will increase by 10 percent this year, China’s leaders appear less concerned than Western observers about the country’s growth rate. No doubt, China’s leaders are somewhat comforted by the fact that the government has a number of tools that can be used to stimulate the economy, if it concludes that stimulus is needed.

First, the government can lift the housing restrictions and stimulate the property sector. Second, China can reduce interest rates and encourage its banks to lend. Except for a six month period in late 2007 and early 2008, China’s benchmark interest rate, at 6.56 percent, is the highest it’s been in over ten years. Third, China can increase infrastructure spending and, unlike many governments around the world, has ample resources to fund those expenditures. Fiscal revenues were 22 percent of Gross Domestic Product (GDP) in 2011, up from 14 percent in 2000. China’s budget deficit was only 2 percent of GDP last year, and total government debt (including the debt of the country’s local governments) was only 38 percent of the country’s output.

China Is In Transition: Rather than stimulate its economy by ramping up infrastructure sending, China is instead making the transition to an economy that is driven by private consumption and investment. The government will most likely ease housing restrictions later this year, and that will help to re-start the property markets. In addition, the government has been taking steps recently to make bank loans more readily available to China’s small and medium enterprises (SMEs), which are the key drivers in any economy.

It started in Wenzhou earlier this year when the government announced that it would conduct an experiment in that entrepreneurial city to legitimize underground finance. Unable to borrow from traditional banks, many SMEs have turned to wealthy entrepreneurs for funding. Although so-called “private lending” is illegal in China and can result in severe penalties for the lenders, it is a $500 billion business. China’s experiment in Wenzhou was the first step in opening up the banking system to private investment and has since been followed by additional loosening measures. More is yet to come.

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