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September 7, 2012

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Home » Business » Biz Commentary

Playing cards right to revive economy

By Chris Leung and Lily Lo | September 7, 2012, Friday | Print Edition

IDENTIFYING the reasons for economic slowdown helps to formulate the correct policy prescription.

China's slowdown is driven by sluggish external demand and deceleration of fixed-asset investment. The former situation is involuntary but the latter one is an intended policy outcome.

Headwinds on the external front are incessantly repeated in news reports and opinion columns. To repeat again, China's exports and imports have fared poorly, coming in at just 1.0 percent and 4.7 percent respectively in July, compared with 10.5 percent and 6.4 percent in the second quarter.

In particular, exports to the European Union contracted by as much as 16.2 percent in July. Export and import growth are projected to be little changed for August at about 2.8 percent and 3.7 percent respectively, putting the trade balance at US$29.7 billion.

Industrial production came in below 10 percent (very rare in the past decade) over April-July and it is expected to be 9.3 percent in August. This also paints a very dire picture for exports in the months ahead.

The primary economic weakness is clearly in the exports-related manufacturing sector, and that naturally calls for a weaker currency. As a result, 0.7 percent depreciation of the yuan so far this year is a logical policy response. Moderate periodic depreciation will not lift exports noticeably, but justifications for near-term appreciation are scarce.

Property controls

On the other hand, the fact that China's slowdown is partially an "intended policy outcome" seldom makes headlines. A few points are noteworthy. For one, property price controls have remained firmly in place, and official rhetoric reinforces expectation that this will continue particularly when property prices have rebounded instantly after two interest rate cuts.

Secondly, in line with rebalancing, a gradual investment slowdown is considered healthy. Fixed-asset investment growth stood at 20.4 percent in the first seven months, down considerably from the peak of 30.5 percent in 2009 and 23.8 percent in 2011.

However, the market should not compare current growth momentum against the "peak" because macroeconomic conditions have completely changed. That's not to say China should sit back and let fixed-asset investment to dive amid the current headwinds from the global economy. There will likely be directive fiscal stimuli soon after the new leadership is on board.

Retail sales, another key component of domestic demand, have actually improved in the past few months. Although nominal retail sales growth have clearly decelerated from 18.1 percent in December of last year to just 13.1 percent in July, retail sales in real terms have steadily increased from 10.7 percent in April to 12.2 percent in July. Also, sales volumes of both BMW and Audi vehicles were up 30.7 percent and 37.8 percent respectively in the first half, clearly defying the general notion of a "very weak economy."

On the monetary side, M2, the board measure of money supply, grew 13.9 percent in July, in line with the People's Bank of China's 14 percent target. New loans are expected to come in at 600 billion yuan (US$94 billion) in August versus 540 billion in July, putting the year-to-date figure at 6 trillion yuan.

The rate of new loan accumulation in 2012 is even faster than 2008, 2010 and 2011. Current levels are similar to those in 2007 (16.1 percent). If the economy is really that weak, loan growth would have been much slower (14.1 percent on average over the second half of 2004, when macro-controls were in place).

There are contradictory signs emerging from all fronts in the Chinese economy. To summarize, positive growth signs include (1) Property prices/volume have already rebounded for three straight months; (2) Retail sales in real terms have improved; (3) Fixed-asset investment growth is holding up and will likely rebound and (4) Loan growth is actually not that weak. The weaknesses are clearly skewed towards the export and manufacturing sectors captured well by trade and manufacturing figures.

Is this the end of the world? The answer is no.

China has so far played its cards right. Its vigilant attitude toward monetary loosening makes sense given the high possibility of the US Federal Reserve's quantitative easing, or QE3, and an imminent rebound in CPI amid higher local and global food prices. The CPI is expected to rise 2.1 percent in August versus 1.8 percent in July. The issue here is not about the CPI itself but that the acceleration of food price inflation will reignite inflationary expectations. That's why, as of now, stringent administrative controls on the property market remain in spite of intensifying weakness witnessed in the manufacturing sector.

Right strategy

The government has allowed slight depreciation of the yuan to provide some cushion against external weaknesses and expansionary fiscal policy has so far been targeted at specific industries. The market may perceive the execution of such fiscal strategy to be too sporadic, thereby lacking the almost instantaneously impact seen in 2009. This is, however, the right strategy to go.

China can spur growth easily by removing the numerous restrictions on the property market. The fact that they have not chosen the easy route shows improving maturity of macroeconomic management that does not aim only at propelling short term growth but also preventing structural problems from deepening further.

Chris Leung is a senior economist for the Greater China region at DBS Bank. Lily Ho is an associate economist with DBS Bank. The opinions expressed are their own.

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