As the world’s third-largest economy – recently surpassing Germany – China was expected by many to be an oasis of growth during the global recession. However, the Chinese economy is in the midst of a bigger slump than expected, not only because of sagging exports, but also moderating domestic consumption. Yet China is better positioned than most countries, developed or otherwise, to ride out the storm.
China has been the world’s fastest-growing economy for 30 years. But growth in China has fallen to its lowest level in seven years. After a stellar growth rate of 13% in 2007, real GDP growth sank to 9% for 2008. According to some economists, growth for 2009 will be in the 5-6% range – the worst in almost two decades.
Industrial production has slowed, with thousands of factories closed and millions of migrant workers losing their jobs and returning to rural areas. Exports fell 13% during the fourth quarter of 2008, putting them 3% lower than the same quarter the previous year. Surprisingly, the decline in exports accounts for less than 50% of China’s slowdown. The bigger culprit is a collapse in housing construction – the result of government moves in November, 2007 to keep real estate prices in check.
Unlike many countries, China has the means to implement economic stimulus measures, with $2 trillion (£1.4 trillion) in foreign exchange reserves, a balanced government budget and low public debt. Moreover, China’s trade surplus has grown 50% over the past year to a record $457 billion.
This jump came as a result of a bigger decline in imports than exports, combined with falling oil prices. As a net energy user, China should continue to benefit from the price reductions which boost the country’s current account balance and bolster its fiscal and monetary flexibility. There is evidence of China’s financial power in the year-on-year growth in money supply (see graph).
The Chinese banking system is one of the few within the main economies unaffected by the global credit crunch. Thanks to a 35% national savings rate – the world’s highest – Chinese banks are flush with cash. Loan-to-deposit ratios are in the mid-60s and, since the banks are state owned, the government can direct credit flow to the economy as needed.
The government has taken several steps to encourage domestic spending. These include a stimulus package allocating $586 billion over the next two years to housing, water and energy projects, airports and railroads, five interest rate cuts since September 2008, with the flexibility for additional decreases, and the introduction of a $123 billion spending plan to establish universal healthcare by 2011.
Other measures saw looser controls on bank lending, a reduction in down payment requirements for homebuyers, and a commitment to spend $29 billion on building a natural gas pipeline, nuclear power plants and a new coal mine.
Much of China’s stimulus programme targets state-controlled companies, particularly those involved with infrastructure development. These firms, which account for one-third of the country’s industrial output, have been ordered to maintain their levels of capital spending and employment. Infrastructure build-out, the primary source of growth for the past 20 years, is critical for China’s economic progress.
Having a robust economy helps support political stability in China by legitimising the Communist government, which puts extra pressure on officials as jobs and businesses evaporate. If the economy cools too fast, China could see protests similar to those in 2008, when jobless workers demonstrated in search of unpaid wages.
Finally, at the global level, China must forge a relationship with President Obama’s administration, which has already signalled concerns about trade, including manipulation of the Chinese currency at the expense of American exports.
The new American administration may also put a greater focus on human rights, as well as address quality-control problems related to many exported products, including toys and foodstuffs. As America’s biggest creditor, however,
the Chinese government has more leverage than in the past – China is the largest holder and buyer of American Treasuries.
With its ample government resources, and its commitment to keep the economy afloat, we expect China to provide an even greater proportion of global growth during 2009 than in 2008, although at a slower pace than last year.
Meanwhile, this can be an exciting time for long-term investors, who can seek to capitalise on the depressed equity prices in the Chinese market. Forward price/earnings multiples fell from 25 times in 2007 to single digits in January, 2009 (see graph). This is a rare opportunity to get in on the ground floor, with many promising companies whose growth prospects remain quite strong for the longer term.