Tuesday, 23 July 2013

China not immune to economic cycles

A few years ago it was China lecturing the United States about structural reforms. Now that Washington has experienced 40 straight months of modest growth the tables have turned. During the first half of 2013, China’s economic slowdown has exposed a Chinese system in desperate need of reform. Hitting the brakes was never a central Politburo plan, but the pace of the global economy has not picked up over the first half of 2013 either and China is moving to implement a Plan B of sorts.

Beijing’s short-term remedies to delay or address key structural problems may not be enough to prevent greater instability. According to the latest figures released from China’s National Bureau of Statistics, the heavily leveraged economy seems to be trending only downwards in direction, and even Beijing expects this trend to continue.

With such a large and complex society which is so reliant on continued growth, the important question is: how much of the present slowdown can Beijing absorb?

China released data recently showing that annual GDP growth slowed to 7.5 percent in the second quarter of 2013. Even though Beijing heartily proclaimed that it officially met its growth target with the latest figures, the data nevertheless confirms the ninth slowdown over the past 10 quarters. This figure - if true, because Beijing is often suspected of fudging the numbers - would be the lowest growth rate for China in 23 years, and analysts suggest the outlook for July to September remains “grim”.

With all the wringing of hands over the latest figures, it pays to keep in perspective the size of the Chinese economy. China still accounts for 13 percent of the world’s global economic activity. And even if the growth figures are closer to 6.7 percent, as suggested by analysts at Seeking Alpha - rather than the official 7.5 percent - these figures would make any European leader smile from ear to ear.

Either way, it is appearing clearer with every passing quarter that China’s growth model of state-led investment with an emphasis on exports is, by Beijing’s own admission, not workable any longer. There are a few reasons for this.

Positive free-trade deals with New Zealand and a close economic relationship with Australia aside, China’s largest trading partners are simply not filing manufacturing orders like they used to, creating an enormous headache for Beijing. Europe is still sorting the details about how it will balance its own chequebooks, while the United States has seen modest growth over the past few years as their economic recovery sputters into life, except in poor Detroit of course.

Because of these changes China will probably never see the same demand for bulk cheap goods return from those regions. Yet to address this imbalance, China is only moving slowly to fill the approaching vacuum.

Two changing highlighted policy steps will be important. Beijing is making agonizing strides to deal with major imbalances in its financial system to move away from an export-oriented economy and towards a structure of greater domestic consumption. Also, developing the Chinese interior to offset the declining pool of cheap labour on the coast – as more working Chinese enter the middle-class – is expected to soak up the rising consumption requirements.

Strengthening domestic consumption is one of Beijing’s alternatives to its failing export model. If more of China’s middle class can spend their money buying goods and services, then it won’t matter very much what happens in Europe or America.

Yet simple government structures which China lacks, such as a robust social welfare system, require people to save a significant percentage of their income to prepare for retirement and health problems later in life. Every yuan saved and not spent on unessential goods slows China’s economy operating under this new model.

On top of this, average consumption has decreased as wealth allocation imbalances have deepened, resulting in a middle-class with drastically shrinking purchasing power as their struggle to find jobs grows more tenuous by the day.

The next three months are likely to see more layoffs as industries struggle to secure credit lines. More bankruptcies as ballooning credit expansion is reined in. Bubbling protests as people discover little alternative to vent their anger and fewer employment opportunities. 

Strategic cash injections from China’s deep pockets will go some way in balancing the Chinese economy – but at the same time will raise jittery international eyebrows - but market expectations are being somewhat tempered as Beijing moves to a more sustainable economic model.

All this movement could lead to a dreaded tumbling effect of financial defaults as Beijing places more restrictions on lending. June’s credit squeeze offered a brief glimpse into what this domino-effect of loan defaults might look like in China. The central bank in China refused to supply promised extra liquidity to the money market in an effort to clamp down on the so-called “shadow banking” economy. As a result, the bond market closed to new issues and a two-week credit crunch created a dangerous default last month.

In this particular case, the policy-driven fiscal measures show that Beijing is willing to tolerate some of the more painful consequences of fixing structural imbalances in the financial system. Yet even with the latest moves, Beijing does not appear entirely ready to implement the necessary raft of reforms. Simply put, Beijing understandably fears a hard landing.

There have been calls to ease the commitment to staunch restructuring, but while this might relieve economic problems temporarily, the inescapable truth remains that China’s growth model needs fixing. Over the vast blue water of the Pacific, Washington is feeling stronger while Beijing has discovered it is not immune to economic cycles.

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