Why China Won't Crack
January 8, 2013
by Milton Ezrati
of Lord Abbett
With so many worries on the horizon, domestic and foreign, recent news out of China should give investors a measure of relief over one of them: concern about a "hard" landing there. Those who earlier peered with Lord Abbett through the headline fears and emotional disappointment over slowing growth could see that this concern was never very likely. But of late, data coming out of Beijing and companies that do business in China have begun at last to cosign the hard-landing fears to the drawer labeled "yesterday's worries." Of course, there is no way China will return to the 10–12% annual real growth rates of earlier in the century. But sustainable growth in the 7.5–8.5% range does look likely, and is enough to keep China in the front rank as a driver of global economic growth, certainly enough to open exciting investment opportunities there, both for direct investors or buyers of equities.
The slowdown in China, which has so frightened investors, has four roots: three temporary, one more fundamental, and all manageable.
Europe's recession and painfully slow growth in the United States lead the list. After all, exports have accounted for more than two-thirds of China's overall expansion, and the European Union (EU) is China's largest overseas customer, while the United States is its second largest. According to Chinese government statistics,1 the Western growth shortfall has slowed Chinese exports growth to a mere 3% so far this year, well down from expansions in the high teens averaged in 2010 and 2011. Nor is there reason to expect much of an acceleration anytime soon. Even with recent progress on Europe's debt crisis, the Continent will take a long time to free itself from its financial and fiscal burdens and return to robust growth. At best, it will show very modest growth in 2013, and even that is in doubt. Neither does it look like the United States will recapture rapid growth anytime soon. But if there is no reason to look for much improvement on this front, neither is there reason to look for matters to get much worse.
If the export picture is still dim, things are improving on the policy front. In 2011, Beijing, fearing a rise in inflation toward 8% or more, ordered the People's Bank of China (PBC) to drain liquidity from the Chinese financial system. It did so, several times, by raising its benchmark interest rate and the percentage of reserves it required banks to hold against their loans and deposits. While this behavior has left a mark on the pace of growth to date, now, with inflation back down to a much more acceptable 2–3% annual rate, the PBC has begun to reverse its policy stance. It has cut its benchmark interest rate and reduced the reserves required of banks. Though it takes time for such a policy change to have its full effect, liquidity has already improved. According to PBC statistics, the broad M22 measure of money in circulation has risen a strong 14.1% above year-ago levels. Bank lending, too, has begun to recover and looks on track to reach 8.5 trillion yuan ($1.35 trillion) in 2012, some 13% over levels in 2011.
China's real estate problems also appear much less devastating than the bears have feared. Home prices are down some 25% from their peak of a couple of years ago, and building activity has slowed accordingly. But still, it would be a mistake to draw, as too many Westerners do, parallels between China's real estate problems and those in America. With Chinese law insisting on 20% down on a first residence and 50% on a second, Chinese homeowners are much less leveraged than Americans were and are. China's debt lies largely with local governments, which, though hardly welcome, are much easier for Beijing to cope with than the widespread subprime debt was for Washington. China also can look forward to a faster work-down of excess housing inventories. Many Chinese have already begun to take advantage of now reduced mortgage rates, especially discounts of 15% for first-time homebuyers. But more fundamentally, there are 11 million marriages a year in China, and some 10–12 million people a year migrate from the countryside into China's cities. Major cities already report increased transactions, and price erosion seems to have stopped. Chinese government statistics on home prices in 100 cities show an end to the price erosion and even a modest rise for some months now.
More fundamentally, China's slowdown reflects a difficult economic restructuring. Beijing has become well aware that it can neither sustain its past pace of exports growth nor rely any more on exports as the economy's sole engine of growth. In the past 20 years, Chinese policymakers note, China's share of the global market has risen from a negligible number to some 12.5%. Since the country cannot hope to redouble this gain, Beijing increasingly has turned to domestic development as a replacement for exports or, rather, as an additional engine of growth. China looks especially to enhance its consumer sector, which still amounts to only 40% of the economy (compared with 70% in the United States, for instance). The expectation is that such an enhancement will balance the economy and buy domestic peace by allowing income and wealth to spread more thoroughly through the economy. Part of China's massive infrastructure spending aims to serve this need. But there is no mistaking that domestic development naturally proceeds less rapidly than export-led growth. If the pace of expansion looks less impressive, the shift should strengthen the economy overall and leave it more stable, making the feared hard landing less, not more, likely.
For the much longer term, there is also a demographic concern. Because the country has imposed a one-child policy on families for the past 30 years, the flow of new, young entrants to the work force has slowed, and will continue to do so in coming years. This trend eventually will hold back the pace of overall economic growth. But it would be a mistake to read too much into this problem too soon. The legacy of what was an extremely youthful population still leaves China with a greater relative abundance of young workers than the United States, for instance, and certainly than Europe and Japan. China today still has almost nine people of working age for each person over 65 years, compared with just over five for the United States and just under three for Japan. Even by 2020, China, according to United Nations estimates, will still have almost six people of working age for each person over 65. The United States will have less than four, and Japan will have barely two. It is a developing economic constraint to be sure, and will in time become severe, but it has little place in an assessment of the next 12–18 months, or even the next five years.
Against such a background, there can be little doubt that China will grow at a slowed pace, next year for cyclical reasons and, longer-term, for structural and demographic reasons. But the hard-landing scenario looks increasingly remote. Figures on manufacturing have already begun to pick up, as have measures of consumer spending. Many of the great multinationals operating in China—from General Motors and Caterpillar of the United States to Rio Tinto of Australia—have reported that China's firming economy warrants increased levels of investment. It looks as though China will meet the official expectation of 7.5–8.5% annualized real gross domestic product growth over the coming 12–18 months. The great potential for domestic development suggests that China can sustain growth in excess of 6.5–7% a year for a long time before demographic considerations come into play. While all these expectations—short, intermediate, and longer term—fall far short of past real growth rates of 10–12% a year, investors and businesspeople need to keep in mind that this anticipated pace still exceeds that expected in the world's developed economies by a wide margin. Most definitely, China seems to be having a much softer landing than popular fears had suggested.
1 All data come from the Chinese government statistical service.
2 M2 and bank-lending figures data come from the People's Bank of China. (M2 is a measure of the money supply that includes M1, plus savings and small-time deposits, overnight repos at commercial banks, and non-institutional money market accounts.)
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