Adjusting for the Future
By staff reporters Huo Kan and Zhang Huanyu and intern reporter Wang Xu
( Magazine) In 2009, there is little doubt that China will "protect eight," official shorthand for ensuring gross domestic product (GDP) growth of 8 percent or greater. The contribution of investment growth supported by credit expansion is especially significant.
Central parity rates for one-year treasury bills resumed on July 8 rose for four consecutive weeks. The China Banking Regulatory Commission reiterated that it would strictly enforce a 40 percent down payment rule on purchases of second homes. After a year in waiting, the "Provisional Law for Fixed Asset Loan Management," meant to ensure that credit flows into the real economy, was finally released on July 27.
Numerous experts interviewed by believe that a marked change in policy in the third quarter is unlikely. But depending on economic growth trends and consumer price movements, some say large macroeconomic policy adjustments could be seen in the fourth quarter of 2009.
Liu Shangxi, Deputy Director of the Ministry of Finance's Institute of Fiscal Science, told that the second quarter was a critical period. If policy were adjusted too rapidly, Zhang said, it could undermine a positive turnaround in the economy.
"Although the Chinese economy is recovering quickly, the absolute level is still low and the economy is still rather cool. So we're not worried about rapid monetary and credit growth, as there is still time for gradual adjustment," said Song Guoqing, a professor at the Beijing University Institute of National Development.
CITIC Securities Chief Economist Zhu Jianfang told that the Central Political Bureau's adjustments indicate that the second half of the year will generally see a continuation of the policies of the first half. There will be no "comprehensive changes," but rather "partial adjustments," Zhu says.
The National People's Congress earlier approved a budget deficit of 9.5 trillion yuan, promising that the deficit would not exceed three percent of GDP. Fan Jianping, director of economic forecasting and chief economist of the State Information Center, agrees that fiscal policy in the second half is not likely to change significantly, and that the central government will not exceed the deficit limit.
"After being over-loose in the first half of the year, creating a sudden shortage in money supply during the second half of the year would be unacceptable," Fan told . Because many projects began work in the first half, there will be inertial demand for loans in order to ensure that projects funded by China's 4 trillion yuan stimulus aren't halted in progress. Although monetary policy needs fine-tuning, "the turn should not be made too sharply," Fan says.
Overt Bubbles and Covert Inflation
More rapid growth than expected in the first half of the year also carries with it numerous risks. In the short-term, these include asset price bubbles, especially in the securities and housing markets.
What's worrisome is not short-term fluctuation in the market, but rather the side effects: as asset prices post continual gains, risk awareness subsides, and bubbles form easily. Might the persistent rise in stock prices up to July 29 and the subsequent same-day tumble become a metaphor for the entire asset market?
A deluge of liquidity creates the perfect breeding ground for swelling asset bubbles. Sun Mingchun, chief China economist for Nomura Securities, says that if macro policies are not quickly adjusted, it could speed up the formation of asset bubbles larger than those of 2007 within the next two to three years or more. How the bursting of such a bubble would affect China's real economy and bank assets is hard to calculate.
Inflation risk, while less obvious than the risk of asset bubbles, should likewise not be ignored.
At present, there are a number of differing opinions on inflation's future role. But the side effects of even potential inflation are obvious. Inflationary expectations are not only a factor in forming asset price bubbles, they are also pushing up interest rates in the bond markets, have recently affected the issuance of national and local debt, and to a certain degree have even affected the implementation of fiscal policy.
In mid-July, three rounds of treasury debt issuance this year went without being fully booked -- the first time in six years. The issuance of 11.2 billion yuan of local government debt originally scheduled for July 13 was also delayed.
Gao Zhanjun, executive general manager of CITIC Securities' bond sales transactions department told that the central bank's resumption of one-year treasury bills and high interest rates in the open market changed market expectations for bond yields. Rising interest rates, coupled with the lifting of an IPO ban, may make the issuance of national debt difficult.
Wang Tao, UBS Securities chief economist for China, believes there is ample liquidity in the market and that fears of the government being unable to sell bonds are unfounded. "Pricing just needs to be adjusted and everything will be fine," Gao says.
However, a "price adjustment" of bonds in fact means higher interest rates. As the economy warms up and expectations of inflation increase, investors demand higher bond yields. Central and local governments can no longer expect ultra-low-cost financing.
"Looking at future trends, the period of ultra-low interest rates is impossible to maintain for long," Fan says.
On July 28, a report titled "Analysis of Second Quarter 2009 Macroeconomic Trends" issued by the People's Bank of China found that worldwide commodity prices had hit bottom and were on an upward trend, creating higher pressure for imported inflation. At the same time, domestic demand continues to increase as liquidity remains ample, and inflation expectations are beginning to manifest. The central bank believes that the CPI will stabilize in the second half of the year, and that the possibility for a growth rebound exists.
In the long run, the stimulus package, which over-relies on investment, may lead to imbalances in investment and the consumer structure. China's economy grew by 7.1 percent in the first half of 2009. Of this, direct investment contributed nearly 90 percent, or 6.2 percent of total GDP growth. Final consumption contributed 53.4 percent, pulling GDP up by 3.8 percent. There has been no improvement in the balance of economic growth.
Wang worries that investment-related credit expansion "on such a large scale" risks two possibilities. The first is an economic rollercoaster in which the economy spikes but has no staying power, putting the sustainability of recovery at risk. The second is that because the majority of investment is coming from enterprises associated with local governments operating on a quasi-fiscal nature, it is easy for resources to be misallocated and there is an increased risk of non-performing assets.
Adjustment Should Come in the Fourth Quarter
The risks are obvious. Although China's macroeconomic policies will not change direction in the near-term, slowing and partial adjustments should come sooner rather than later.
"From now on, the central bank will say that they won't adjust (policy), but in reality they'll be fine tuning, and in the fourth quarter they may act more aggressively,” Wang added.
After fine-tuning, whether or not monetary policy gets a more intense adjustment will depend on the level of credit expansion in the second half of the year. Fan Jianping believes that if commercial banks continue to inject significant amounts of credit into the market, policy makers may need to use tougher measures to rein in liquidity, such as lowering interest rates or reserve ratios. But "this isn't good for China's economic recovery," says Wang.
Wang says that adjusting reserve ratios should be a form of fine-tuning, but because the market often views such changes as large adjustments, the central bank is reluctant to send such a signal, and is thus unlikely to make the adjustment.
As to when interest rates may rise, Nomura's Sun Mingchun predicts early 2010 as the most likely time. The key is to look at the scale of new credit growth. If growth exceeds expectations, he says, "we could see higher interest rates by the end of this year."
Speaking on state investment as a single-engine growth driver, Fan suggests that new projects should be controlled. "In the second half, we should strictly control the quality of projects. If projects aren't required immediately by the national economy or don't represent the most effective way to stimulate the economy, they can be postponed.”
In the first half of 2009, there were nearly 1.8 million new projects, an increase of 43 percent over the previous year and worth a total planned investment of nearly 7.4 trillion yuan -- massive investment growth of 87.3 percent over the first half of 2008.
Liu Shangxi believes that, "If growth in the second half continues to accelerate, policies may be adjusted."
By July 27, China's 31 provinces, municipalities and special administrative regions had all reported results for the first half of 2009. The 22 provinces all grew at over 8 percent in the first half. Of those, 14 had GDP growth exceeding 10 percent. Tianjin and Inner Mongolia had average growth of 16.2 percent.
The economy in its present state has already increased momentum. "Investment should not be the only issue. We need overall development, and special emphasis needs to be placed on how to stimulate consumer spending," Liu says.
"The most basic way of encouraging consumer spending is to focus on balancing distribution of income." Liu believes that income distribution needs to start leaning toward the common people, reversing the trend of government income and corporate profit growth exceeding GDP growth while growth in per capita income lags. One of the most plausible current suggestions is to use dividends from state-owned enterprises to replenish social security funds.
Zhou Tianyong worries that as many local governments increase fiscal expenditures and try to collect more tax and especially non-tax revenues, public revenue intake may affect the survival of some small and medium-sized enterprises and lead to unemployment. "This will not increase consumption; it will stifle it."
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