Thoughts on China’s 12% GDP Growth
Yesterday, China announced that its economy’s GDP grew at an annual rate of 11.9% in the first quarter (January-March) of 2010. It’s a number that’s sure turn envious heads in the West, and cause people to wonder whether there are any heights that the Chinese economy won’t reach. Soon after the GDP figures were released, I was interviewed on CCTV-9’s nationwide news program, to offer some perspective. You can watch the interview here (the link is to the entire 1-hour news show, my portion begins at the 39-minute mark).
The question, I cautioned, isn’t whether China can produce spectacular GDP growth figures, even in the face of a global slowdown — it already proved that last year. The question is how sustainable that growth will be. And in this respect, there are two main concerns.
The first is that a large chunk of China’s GDP is coming from investment in fixed assets such as factories, real estate projects, and infrastructure (in 2009, fixed asset investment accounted for 90% of China’s net GDP growth). GDP only measures how much is being invested, but not the return on those investments, i.e., whether they are good or bad. Given how much has been invested so quickly, there’s a lot of concern that many of these investments will prove to be poor ones, the cost of which could come back to haunt China’s economy. This is similar to a point I made in post last year on China’s “quality of GDP”.
The second concern is inflation. To the extent that China’s fast-paced growth is being fueled by easy credit and money creation (China’s money supply expanded by 1/3 in 2009, and is up 22% over 1Q last year), it could be inflationary. Consumer inflation is running at 2.4%. That already exceeds the regulated deposit rate of 2%, which means that Chinese savers are effectively losing money by keeping it in the bank. But a lot of economists are wondering why the inflation rate isn’t even higher. I think there is very high inflation out there, in the form of asset inflation in real estate and the stock market, where a lot of that cheap credit has been channeled — it just hasn’t worked its way through the rest of the economy yet (for more on this, see my post on “Crouching Stimulus, Hidden Inflation”). The fact that China’s central bank has to constantly strive to counteract the inflationary effect of the new RMB it is forced to issue to maintain the US dollar peg isn’t helping, either.
These two worries — bad investments and inflation — mean that China’s sky-high GDP growth is not necessarily as good news as it might seem. The headline number may be impressive, but it could come with a steep price tag.
On a separate but related note, AFP ran a story yesterday on how a stronger RMB might impact China’s exporters. Near the end, it quoted me and an RBS economist both noting that while a weak RMB may be good for exporters, it might not be so good for China’s economy as a whole:
Economists say a strong yuan is essential if China wants to achieve its goal of reducing its heavy reliance on exports and boosting private consumption as a driver of the world’s third-largest economy.
“Exporters will suffer from a stronger currency,” said Ben Simpfendorfer, an economist at Royal Bank of Scotland in Hong Kong.
“But currency appreciation will also force the pace of structural adjustment in the low value-added export sector, which is a necessary part of domestic rebalancing.”
The exchange rate policy has propped up poor performing exporters at the expense of the broader economy, said Patrick Chovanec, an economics professor at Tsinghua University in Beijing. “It’s important to ask why exporters are currently doing well or remaining in business. Many of them can only do so because they’re able to exchange the dollars they earn for yuan at the peg,” Chovanec told AFP.
“That’s great for exporters but the central bank has to buy all those dollars at the peg, invest them, and neutralize the inflationary effect. That’s a significant burden.”
I’ve mentioned several times on this blog that while I do not believe strengthening the RMB is a “silver bullet” for resolving the trade imbalance between China and the US, I do think it’s in China’s long-term interests to move towards a more flexible exchange rate, and that a stronger RMB — if it is part of a comprehensive economic strategy — could bring substantial benefits as well as short-term pain to China.
On the question of whether China’s March trade deficit signifies a trend toward real economic restructuring and more balanced trade or merely a “blip on the radar screen” — a subject I raised in my last post — I highly recommend checking out Rachel Ziemba’s latest post at Nouriel Roubini’s website. She’s asking many of the same questions I am.
Patrick Chovanec 
The only direct conclusion you could draw for a large reserve is China produces more than it consumes. As to how to balance that, there are essentially two ways. You could strengthen the RMB to kill the exporters so that production can come down to the consumption level. Or you could find a way to boost domestic demand so there is no need to export so much for green papers. Which way is good for China? Well, if you are a rational person and you are not biased, you could see clearly which one to go. Almost all (except Roach maybe Stiglitz) western controlled media and pundits are calling for a RMB revaluation in the name of benefiting China without explaining how (because they don’t know how and it won’t), I think it is easy to see why if you have a simple and clear view of the issue we are dealing here.
When the Chinese housing bubble bursts, I’m afraid RMB needs to devalue to save the country from collapsing.
The headline Q1 GDP growth rate is misleading: it is a yoy rate and last year’s Q1 GDP was the lowest in almost a decade. So the 11.9% reflects much of the recovery (Singapore’s Q1 growth rate, by the way, is over 30%).
“in 2009, fixed asset investment accounted for 90% of China’s net GDP growth”
Quoting this number without context is misleading. It gives people’s impression that China’s economy was overwhelmingly driven by investment and, for those with a preconceived bias of China’s economy, this number is Godsend.
The reason this number is misleading because it does not tell you that last year, China’s consumption growth was higher than GDP growth, the first time it happened in quite some time. In addition, last year was not an ordinary year, as everyone knows, and the strong stimulus program naturally drove up the fixed-asset investments, which compensated the negative contribution of export.
I would agree with you about the quality of GDP, though. Growth rate higher than 10% in China, in my opinion, runs the risk of incremental poor GDP and mis-investment in a normal year.
What China needs most now are structural reforms, with RMB exchange rate mechanism but one of many changes that are necessary. China should allow a more flexible RMB exchange regime. This should be done gradually, however, to avoid deflating the asset bubble too quickly.
I don’t think any policy-makers in China seriously doubt China should allow the RMB gradually appreciate and be more flexible. However, the importance of RMB issue has been oversold and has been a huge dis-attraction and waste of time for the western media.