Betting on Chinese growth

Lowy Interpreter

With the European economy still teetering and the US recovery fragile, the world is heavily reliant on China to put in a good growth performance.

So far so good. After 9.2 per cent GDP growth in 2011, the first quarter of 2012 recorded a respectable eight per cent annualised growth rate. While this was a bit below expectations, other data have caused one of the growth-pessimists, Nomura, to reassess its 2012 forecast of 8.2 per cent, with an upward revision pending. The freshly-released Asian Development Bank outlook forecasts 8.5 per cent growth this year, speeding up a little next year. The IMF forecasts much the same growth profile, despite a weaker investment outlook. It warns, however, of the 'clear and present danger emanating from Europe'.

Remarkably, given China's reputation for growing by sucking in demand from the rest of the world, the 2011 figure was achieved without any help from the external sector: the growth in imports was higher than the growth in exports.

The long-awaited re-balancing seems to be underway. At the height of the US complaints about China's exchange rate undervaluation and over-saving, China's current account surplus was running well over 10 per cent of GDP. In 2011 it was just over three per cent of GDP. The ADB sees this external surplus falling to two per cent this year and 1.5 per cent in 2013.

Investment was the main engine of growth in 2011, and the ADB forecasts rely on this growing twice as fast as GDP in the two forecast years. Investment accounted for almost half of GDP in 2011 and this forecast implies it will be larger still in the future. This has caused a new round of hand-wringing about whether there is over-investment. If there is, will this be the cause of a hard landing?

Leading the optimists is The Economist, citing much evidence that despite the cracking pace of Chinese investment in recent years, China's capital stock is only eight per cent of America's and 17 per cent of South Korea's, leaving plenty of room to expand without following Japan's example of bridges-to-nowhere and concreting every river bed. Despite the need to restrain the recent housing boom, in the longer term China needs many more dwellings, with one-third of urban residents living in poor-quality collective housing and lots more rural peasants waiting to join the urban crush. China may have built some fast-trains-to-nowhere, but there is plenty of productive investment waiting to be done.

Leading the pessimists is Michael Pettis, who predicts that 'by 2013-14 Chinese GDP growth will slow sharply, and by 2015-16 predictions of a sustained period of growth rates at three per cent or lower will no longer seem outlandish'.

Pettis looks at the prospect of re-balancing and sees challenges on both the political and the economic side. He may turn out to be right, but China is still in a better position to maintain seven to eight per cent growth than Europe or the US are to meet their more modest forecasts. The key adjustment requires lifting Chinese household consumption from its current share of less than half of GDP to a more normal figure like two-thirds. This seems an infinitely easier political task than the challenges facing Europe, and China's decision-making capacity is a lot more centralised.

China doesn't have enough policy slack to repeat the huge stimulus of 2009; the ADB estimates that government debt, including contingent liabilities from financial sector problems, is now 80 per cent of GDP. But Beijing can certainly provide another healthy stimulus if needed.

Originally published by The Lowy Institute publication The Interpreter. Reproduced with permission.