[Mb-civic] China: A reheated economy Jan 25th 2005

Thu Jan 27 10:42:44 PST 2005

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Economist.com      

A reheated economy
Jan 25th 2005
>From The Economist Global Agenda

China¹s economy re-accelerated in the last quarter of 2004, despite official
efforts to curb rampant investment. Is it growing too fast to keep its
balance?

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ON TUESDAY January 25th, the Chinese authorities sheepishly confessed that
the economy beat expectations last year, growing by 9.5%. It finished the
year particularly strongly, growing at an annual pace of almost 13% in the
last three months, according to J.P. Morgan. Anywhere else, this would be
cause for celebration. But in China, the firecrackers remain unlit. Instead,
analysts and investors are trying to reassure themselves that this is not
bad news.

Economists, who freely mix their metaphors, have spent the past year
worrying that China is ³overheating² and hoping that it will make a ³soft
landing². Their worries reached a peak in the spring, when China¹s banks
were lending freely, investment was expanding blindly and prices were rising
quickly. This anxiety was shared by the Chinese authorities. In April, Wen
Jiabao, the prime minister, said China would take ³very forceful measures²
to cool the economy. The authorities imposed curbs on investment in sectors
such as steel, aluminium and cement, refused to release land to developers
and threatened to impose price controls if inflation remained out of hand.
In October, the central bank raised interest rates (if only by a little) for
the first time in nine years.

By the winter, however, hopes of a soft landing were high. Inflation was
ebbing, investment was cooling and output was slowing (see chart). Most
economists expected Tuesday¹s figures to show a further slowdown in growth.
Instead, its pace has quickened. The Chinese economy has taken a puzzling
detour on its gentle route back down to earth.

The world¹s most populous country has vast reserves of labour and no
shortage of capital. Why, then, should we worry that it is growing too fast?
Since China embraced market economics in 1978, its average rate of growth
has been 9.4%. By its own standards, then, last year¹s pace of expansion was
nothing out of the ordinary.

But economists are anxious about the balance of China¹s economy as much as
its speed. China may or may not be growing too fast, but it is certainly
investing too much. In the year to the first quarter of 2004, spending on
fixed assets‹plant, property and infrastructure‹grew by 43%. Investment
accounted for 42% of GDP in 2003, and perhaps a still greater share last
year. No economy can sustain such a colossal rate of capital accumulation.
At some point, China¹s investment must run into rapidly diminishing returns.
Are two cement factories twice as good as one?

If investors were betting their own money, these redundant cement
factories‹not to mention steel mills, luxury flats and car plants‹would
probably never have been built. But China¹s reckless investment owes a lot
to the heedless lending of its banks. Chinese households still save about
45% of their income. They deposit about two-thirds of these savings in
China¹s four big state-owned banks, which lend about two-thirds of these
deposits to state-run firms. The banks pay little attention to risk and do
not expect much of a return: perhaps 40-50% of loans are non-performing. In
fact, their lending is best seen as a form of state subsidy. If these
subsidies were added to the government¹s books, China¹s budget deficit would
balloon to 18% of GDP, reckons Diana Choyleva of Lombard Street Research, an
economic consultancy.

Suppose, says Ms Choyleva, that China can sustain a rate of investment of
about 35% of GDP, rather than its current rate of 40-45%. How does it get
there from here? Such a sharp contraction in the investment rate is not, she
says, consistent with a soft landing. If investment slows, the economy as a
whole will plummet. China, she predicts, cannot escape ³the natural
violence² visited on all developing countries that go through such
boom-and-bust cycles of investment.

Those who still hope for a soft landing agree that China¹s rapid rate of
investment must slow. But they hope that exports and consumption can take up
the slack. They will draw some comfort from Tuesday¹s figures. Investment in
fixed assets grew by 21.3% in the year to December, its slowest pace in
seven months. And yet the economy still quickened. Exports jumped by a third
to $63.8 billion in December. Rural incomes, boosted by a bumper harvest,
grew by 6.8%. And in the cities, real disposable incomes increased by 7.7%
and retail sales by 14.5%.

Since 1978, China¹s communists have let thousands of private firms bloom,
from small-town enterprises, growing organically, to giant manufacturing
concerns, built with foreign money. According to Tuesday¹s figures, China¹s
economy is still sprouting vigorously. But some still fear that too much of
this growth will turn out to be dead wood.