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China's Economy

The High-rolling Days Are Over

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The High-rolling Days Are Over

Source:Kuo-Tai Liu

China's blazing economy, where investors could take high returns for granted, is a thing of the past, as some experts predict a second economic slump.

The High-rolling Days Are Over

By Sherry Lee
From CommonWealth Magazine (vol. 449 )

In his annual opening address to parliament earlier this year, Chinese premier Wen Jiabao was confident about China's economic prospects for this year, arguing that the economy's stronger sectors would take the lead and be the focus of government efforts. Just weeks ago, however, his tune had changed.

"We must closely monitor conditions and make adequate preparations for a 'second downturn' in the global economy," Wen exhorted listeners on May 31. "Right now it is still too early for China to withdraw from economic stimulus policies."

Official Chinese forecasts conservatively predict eight-percent growth in gross domestic product (GDP) this year. The Economist Intelligence Unit (EIU), meanwhile, has gone so far as to predict that China's economic growth in 2010 could reach as high as 9.6 percent. But in a paper recently delivered at Beijing University, Yu Yongding, director of the Institute of World Economics & Politics of the Chinese Academy of Social Sciences, remarked: "I've always had considerable confidence in my judgments of general macroeconomic trends, but since the second half of 2008, I really don't dare discuss Chinese macroeconomic trends."

China's Economy: A Double-Dip Recession?

In a recent interview, Essence Securities chief economist Gao Shanwen, who has for three years running made the most accurate Chinese economic growth forecasts, projected that China will follow the world economy into its second recession since 2008. The growth rate during the second half of 2010 will slow down relative to the first half of the year, although it will not drop below eight percent. However, Gao foresees no real driver of high economic growth rates for the next two to three years. Profits in excess of 20 percent at listed companies are also a thing of the past and can be expected to decline sharply, he contends.

The high-rolling investment environment of the past 20-odd years, and the high returns China investors expect, are in the process of vanishing.

As a developing economy playing catch-up ball, China has long relied on massive levels of investment and massive production capacity to drive high levels of economic growth. For the next six months to a year, however, even if consumer spending accelerates, government and private investment, the biggest drivers of GDP growth, are poised to cool down.

According to figures from China's National Bureau of Statistics, the ratio of China's fixed investments to GDP last year stood at 47 percent and accounted for 92 percent of economic growth that year.

The primary reason behind China's rapid recovery in economic growth in the period following Nov. 2008 was the rapid proliferation of new state investment items, such as the government's four-trillion renminbi effort to stimulate domestic demand.

According to Yu Yongding's assessment, China's leaders have already indicated that there will be little growth in new state investment items, and overall investment will be curtailed. Additionally, the pace of growth in property investments, which currently accounts for one-quarter to one-fifth of all investment in China, has to date been on the decline.

Other major factors in the big chill in Chinese investments is China's excess of mass production capacity, the outbreak of the European debt crisis, and the U.S. Obama Administration's efforts to boost American exports, all of which have combined to drive down demand for Chinese exports, leaving the investment outlook more conservative.

Last year China's overall trade surplus stood at US$198.1 billion, barely two-thirds that of the previous year's US$297 billion, while in March of this year China for the first time posted a trade deficit. While China retains its low-cost competitive edge, its avenues for increasing exports are not as clear as they once were. Due to excess mass production capacity and a worsening export environment, China's government and private sector are both now facing a complete readjustment of the industrial structure.

3 Big Worries, Short-term Containment

In the medium- to long-term, what China faces is an economic structural transition. But over the next six months to one year, there are three major internal short-term anxieties.

Foremost among these are skyrocketing wages across the low end of the labor market.

Comparing figures from 2003 and 2009, annual wages for workers in eastern China grew an average 11 percent annually, from 760 renminbi in 2003 to 1,422 renminbi in 2009. The figure for central China was 15.5 percent annually (570 renminbi to 1,350 renminbi) while that for western China was 16.2 percent (560 renminbi to 1,378 renminbi).

Wages for unskilled labor have grown at an even faster clip than the 9-percent economic growth over the past three years and might even reach 20 percent in the future. Whether China can repeat the experience of Japan in the late 1960s and accelerate the production efficiency of its workforce amid rapidly rising wages poses a major challenge for the economic competitiveness of both China and its business community.

Second, there is the crisis of the property market bubble.

Comparing the ratio between housing prices and rents in 22 major cities around the world, Huang Yiping, a professor at Beijing University's National School of Development, found that Beijing and Shanghai had the two highest price/rent ratios in the world, far in excess of reasonable standards. The property market bubble remains extremely serious.

Despite that, in May the total floor space of commercial and residential real estate transactions across 30 major Chinese cities declined 44.18 percent, leading some to conclude that China's property market has cooled sufficiently and that there is no danger of a bubble.

This belief, however, may be entirely delusional.

As Peng Cheng, a Citibank China economist, notes, the growth rate in land area acquired by property developers has accelerated to its highest levels since 2003, while there has been a decline in growth of land area actually developed. Further, during the first quarter of this year, the central bank announced that more than 800 billion renminbi of the more than 2 trillion renminbi in new loans, or about one-third, flowed into the property market. This would seem to indicate that major property developers are proceeding with caution, but market demand from newly married couples, retirees and speculators has yet to cool. Many economists, including Peng, believe that even if the central bank takes quick, hard action to rein in property prices, it will do little to address the root of the imbalance in the property market, and China's property bubble will have even more room to grow worse.

The third concern is the crisis in the explosion of non-performing loans extant among local government financial institutions.

Statistics from the central bank's China Banking Regulatory Commission show that local government entities undertook 7.38 trillion renminbi in loans last year, about 20 percent of all lending and nearly equivalent to the roughly 8 trillion renminbi in total central and local government revenues. And a considerable portion of the seven-plus trillion in lending is government-assured. Economists fret over local governments' abilities to service those debts.

Looking to the future, China is facing a tremendous transition and brewing internal pressures. Businesses and investors alike must come to grips with the reality that the breakneck pace of China's economic growth is slowing. Over the next two to three years, old notions of high economic growth rates and high investment returns will have to be discarded.

Translated from the Chinese by Brian Kennedy

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