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China: Preparing for a Soft Landing

Raymond Goss


An expanding economy and its implications on the world

Lately, economists have been worried that China’s sky rocketing growth trends are doomed for a hard landing crash. Recent GDP numbers have put these fears to rest, at least temporarily. However, future growth will have to be managed carefully and the Chinese government has to maintain a delicate balance in order to avoid a crash and burn scenario, particularly the impact on the rest of the world.

Stepping back in time

At the height of his power in 1421, Emperor Zhu Di of the Ming Dynasty moved his capital from Nanjing to Beijing and invited foreign dignitaries to revel in the glory of his newly constructed ‘Forbidden City’. A true wonder, the Forbidden City was 1500 times the size of walled London, and housed 50 times London’s population.

In order to construct the City, a vast canal of 1800 kilometres was built to carry supplies needed to feed and house over 3 million workers and 1 million soldiers. So huge was the demand for food that famine broke out in the outer provinces. The large quantities of timber used caused deforestation and flooding in China and its neighbouring countries.

To avoid the devastating consequences of social unrest, China embarked on a period of expansion – marked not by conflict and colonization as was the European custom, but by trade, influence and, if required, bribery.

We can draw many insights from this period: the endurance of Chinese culture, its sheer scale and the consequences for the rest of the globe, which is, to some degree, influenced by Chinese economic cycles.

History repeats itself

Fast-forward a few 100 years. Today the Central Party views economic development as the yardstick of performance and the key to social stability. The Chinese single-minded pursuit of economic growth has resulted in an average annual economic growth rate of over 10% since 1980 and has lifted approximately 500 million of its citizens out of poverty. The last 30 years have been characterized by enormous capital spend, urbanization and growth in exports where China focused on quantity of production and positioned itself as the “workshop of the world”.

Initial responses to the crisis – a delicate balance

The 2008 economic crisis was devastating as America, Europe and Japan entered recession, freezing and reversing growth in exports. The Chinese authorities responded with unprecedented levels of economic stimulus, injecting 4 trillion yuan (USD630 billion) into its economy through a bank-lending program. The economy responded, moving to 9% growth in 2009, 10% in 2010 and 9.2% in 2011. The downside of easy money was, not surprisingly, speculative property inflation and consumer price inflation.

To avoid a destabilizing inflationary outburst, the People’s Bank of China tightened policy aggressively, raising interest rates and lifting bank reserve requirements. Restrictions were placed on multiple property purchases, demanding down payments from buyers and a cap on lending to developers. These restrictions remain in place. With the major engines of global economic growth knocked-out or idling for the foreseeable future, the question of a “hard landing” for the Chinese economy was and still is a possibility with chilling consequences for the global economy.

The key concerns for Chinese policymakers revolve around inflation and speculation. It is very likely that Chinese authorities will respond aggressively to any economic slump which would raise the spectre of social unrest. With inflation starting to slowly recede (moving to a level of 5.5% in October), the Central Bank has started easing restrictions, cutting reserve requirements at the start of December 2011.

Hard or soft landing?

Many analysts believe that China is well positioned to avoid a crash or significant write-downs of property valuations. With USD 3.2 trillion in foreign exchange reserves, the highest in the world, they could absorb non-performing loans if they were to rise unexpectedly. The immediate challenge for Beijing would be to reduce the dependence on government driven investment and to encourage private sector growth and consumer spending to sustain a durable expansion in the long run.

Consumer spending at 34% of GDP, is roughly half of that in other developed nations. A failure to shift the economy would have major consequences in years ahead and would leave the economy vulnerable to the weakness of developed economies, increasing the threat of global trade wars.

An impact on the world

What if China does have to face a hard-landing? What would that mean for the rest of the world?

The high level of growth experienced recently has meant that hundreds of millions of Chinese have begun to demand a better quality of life and the material belongings this brings with it. The appetite for fuel, metals and food has meant that China has become a major consumer of materials and resources and has, by necessity, become an importer of these goods.

A reversal of this would have major implications for its trade partners, in particular the commodity rich countries that are supplying these goods. Countries like Brazil, Australia and South Africa would be very vulnerable to such a slowdown.

The effects for developed economies such as America would be mixed with its large multinational corporations suffering significant slowdown in growth whilst the broader economy would be supported by lower commodity prices, and in particular, oil.

The Chinese economy is today less dependent on export growth and so less vulnerable to the European recession. That said no economy has been able to grow from emerging to developed status without going through a number of economic crises. The Chinese authorities have a balancing act to play in terms of managing their growth, and are vulnerable to external as well as internal pressure and a very fragile global economy.

China’s challenge in 2012 will be to stimulate the economy to maintain stable growth without reviving some of the problems of its past. Only time will tell if history repeats itself.

Raymond Goss
Joint Head, Wealth Management
Investec Wealth & Investment (SA)

The opinions and views expressed are for information purposes only and are subject to change without notice. They should not be viewed as independent research, recommendations or investment advice of any nature.