Macroeconomic Monitor: China in 2012 - Soft Landing?
This year marks the beginning of a trying period for China's economy. As it aims for a soft landing, it will find itself in the midst of a fundamental transition, and the economic indicators have already begun to reflect these new trends. By Kirill Riabtsev
In Q4 2011, China reported GDP growth of 8.3%, down from 9% in Q3 and 9.6% in Q4 2010, achieving an average rate of 8.9% for the whole year (see chart to the right). Leaving aside any long term trend benchmarking, this growth is still impressive. However, even though moderation was expected and even welcomed, some observers have raised concerns about the large drop between Q3 and Q4, compared to the rates observed in the previous three quarters. Sceptics were quick to discern the beginning of China's economic collapse, while the devotees of China's growth miracle argued for the positive effects of the cooling economy, which should result in moderation of inflation and reduction in overinvestment, thus curtailing any further bubble trends. But what about China itself?
Changing weather conditions
Premier Wen Jiabao stated that slowing growth, combined with persistent price inflation, adds new challenges to the management of the second-largest economy in the world. However, the disinflationary process appears to have already kicked in during Q4 of 2011. In December, China's CPI moderated to a 15-month low of 4.1% y-o-y, while PPI experienced a sharp decline due to significant decreases in both the international prices of raw materials and domestic demand (see chart below). China's official PMI recovered in December 2011 as new orders edged up, capacity utilisation added 9.3 points, hiring stepped up and credit conditions jumped 15.9 points, but an overall stable downward trend persisted through the year. On the other hand, retail sales kept firm, increasing in 2011 by 17.1% y-o-y, supported by further growth in wages and incomes per capita, while export growth continued a steady decline with December 2011 showing the slowest export growth since February 2011 (see chart below).
Focusing more closely on exports, one can see that trade with the Eurozone, Japan and the United States have continued a stable decline in 2011 (down by another 2.3% from 2010), while intraregional trade with ASEAN economies grew further, adding another 4.2% to the total (see chart on next page, top right). At the same time 29.3% of total government expenditure in 2011 went towards further strengthening consumption via increased education and better social safety nets such as healthcare insurance. Finally, these trends are observed against the backdrop of a moderate decline in fixed asset investment (-0.4% in 2011), stable average month-on-month growth (2.3%) in property sales (compared to 14.1% in 2010) and a 5.2% growth rate (2011) in new passenger car sales, forecasted by the China Association of Automobile Manufacturers to grow between 5% and 8% in 2012.
Although it is still early days, these observations reflect potentially new long-term trends. As China can no longer rely on exports of manufactured goods to the rest of the world for sustaining its own economy, increased domestic consumption must gradually become the main engine of the economy. Enormous production capacity was created through large fixed asset investments over the past decade to cater for export-led growth in manufacturing. The 12th Five Year plan, however, rolled out at the beginning of 2011, was underpinned by the need to transform China's economic growth mode away from investment and exports and more towards consumption. The figures closing 2011 suggest that the shift towards greater reliance on internal demand away from exports has already started (slowly, but that would be expected).
This shows how quickly China can begin reorganising and remodelling its economy with top-down coordination and quick reactions from all key sectors of the economy. Increasing social spending, stabilising (not radically falling or persistently rising) trends in the housing market and fixed asset investments, as well as emerging disinflationary trends against the backdrop of moderately growing real per capita incomes, and a robust outlook on key consumer goods (e.g. passenger car sales), indicate that the wheels have started to turn in the right direction and China is beginning to shift away from an outward-focused towards an inward-driven economy.
Yet key challenges remain. Managing aggregate demand is arguably a much more tricky process than managing aggregate supply, as the economies of the West have recently demonstrated. A massive monetary injection into the system does not always serve as an automatic stabiliser of falling consumption, if underlying perceptions of the consumers are negative. In China, the desired rate of growth in consumption on the back of policy stimulus may be constrained by the traditionally high propensity to save. In light of that, Beijing must find the balance between curbing inflation and preventing a hard landing. A monetary stance that is too tight will combat inflation but undermine growth in the short term, possibly to the point of a hard landing; easing too quickly will mean that inflation will recur which will undermine growth and structural integrity in the longer term. In finding the balance, Beijing must interpret complex domestic and international developments. A weak global backdrop in developed countries, especially in Europe, adds considerably to the risks in balancing policy.
Soft landing, but bumpy approach
Our view is that China's growth will soften further in the first half of 2012, but the slowdown will not be severe. Hence, we do not see a hard landing. We expect China's GDP growth to ease to around 8.5% in 2012 (from 9.2% in 2011 and 10.4% in 2010). Beyond 2012, we see GDP growth of 7.5-8.5% over the period 2013-2015. But this period will present the biggest policy challenges to Beijing in 30 years, and it will be necessary to carefully gauge the relevant risks. Given the overheating pressures during much of the period from 2002 to 2011, more moderate growth is desirable and indeed more sustainable – provided that China grows at around 7.0-7.5% or more – which will still allow Beijing to deal with its social and development agenda. Even with moderation in GDP growth, the investment sector will remain an important driver. Infrastructure development and social housing will be a focus as private sector real estate growth is curtailed. Increasingly, consumption will complement investment as a driver while China's broad-based transformation continues. Both underpin ongoing commodity demand, providing a generally sound backdrop for resource producers such as Australia, Africa and Latin America.
The above represents a base-line view. However, uncertainty continues to linger in Europe. There is a possibility of a marked further deterioration in the fiscal landscape, and even a break-up of the Euro. A severe deterioration would have a negative global impact and not less so for China. The relevance of the Eurozone crisis for China has been demonstrated by recurring discussions between Chinese and European leaders on the possibilities of China providing funds to the troubled economies of the EU. At the same time, in the last week of December 2011, China began discussing currency pairing arrangements with Japan and announced currency swaps with some of its Southeast Asian trade partners.
These moves indicate that while China recognizes that, in the longer run, greater reliance on the domestic consumer is the way forward, over the short and medium term, such change must be supported by significant reorganisation of trade flows, and further shifts away from troubled developed markets and increasingly more towards emerging economies. In the short run, net exports will remain the backbone of China's growth, and given global weakness in developed markets, substantial uncertainty about their performance persists. A positive effect of this, however, is that such uncertainty will further shift the economy towards domestic demand and may significantly speed up this positive transition, which, according to the 2011 figures at least, has already started.
Kirill Riabtsev, Senior Project Consultant