To the PointDiscussion on the economy, by the Chief Economist August 31, 2012 China – a potential watershed for global growth Economic activity in China is slowing considerably, and the risk for a hard landing has increased. Our main scenario is GDP growth of just below 8 % this year, and a moderate amount of stimulus to counteract the slowdown. The effects on the global economy if China’s economy landed harder should not be underestimated as China alone accounts for 50% of global growth. Financial and commodity markets would also be affected, as would geopolitical and trade relations. Cecilia Hermansson Slowdown means firing up the investment engine again Group Chief Economist Economic Research Department Much has been written about the financial and institutional crisis in the euro area and +46-8-5859 7720 the risk that US would “fall off the fiscal cliff” if, after the presidential election, firstname.lastname@example.org Congress could not make up its mind on next year’s budget. Yes, these two factors represent very large threats to the world economy. Equally important, however, is the Chinese economy since, if it were to land hard and lack proper management going forward, the global economic climate would look so much chillier. There are important questions to be raised at this point: How much is China slowing down? How much stimulus can we expect to come from monetary and fiscal policy? Will the Chinese authorities stick to the plan to rebalance economic growth from investments/exports to household consumption? China’s slowdown has accelerated lately. The second quarter saw GDP growth of 7.6%, which means relatively slow quarterly growth of below 2%. Other signs of slowdown include the levelling off of electricity production, the weak signals from purchasing managers, smaller inflows of foreign direct investment, and decreased demand for commodities in the global market. Developers’ unsold property has now reached 3 million units, compared with 2 million units in 2008, and the growth rate of real estate construction is falling close to the historical lows seen in 2009. Another sign of slowdown is the export growth of only 1% in June, and the authorities’ reluctance to let the renminbi appreciate further against the US dollar (it is still rising against the euro). Between May 2010 and December 2011, the renminbi appreciated by almost 8% against the dollar in nominal terms (and more in real terms), but thereafter it has depreciated by about 1%. This policy protects exports. It is hard to estimate the amount of stimulus that can be expected from the Chinese authorities to counteract the slowdown. The stimulus programmes in 2008-2009 accounted for 13% of GDP during those two years, but it is unlikely that the stimulus can be as large this time. The People’s Bank of China (PBC) has cut the lending rates a couple of times, but these are still at higher levels than were seen in 2008-2009. Reserve requirements have been lowered for small and large banks, and credit growth is again picking up – although we hope not to the rates seen after the last crisis, which resulted in overheating. In addition, open market operations have led to injections of liquidity into the monetary system. All in all, the PBC will do more to make monetary policy more expansionary, including lowering the reserve requirements further. On the fiscal side, the authorities cautious about relaxing control measures on the property sector since the risks of overheating in that sector could increase again. Prime Minister Wen Jiabao wants to “stabilise growth, including promoting consumption and diversifying exports, but currently the main task is to promote reasonable investment growth” (see the July 17th The Financial Times). This means that the authorities are ready to fire up the investment engine again even if the investment ratio to GDP is already 49%. If the local governments’ pledges for stimulus can be believed, then the measures look bigger than in 2008-2009, however, No. 8 it is unlikely that all of these pledges will be realised since funding at the local level is lacking. The process of rebalancing would be postponed if growth were to falter. Still, 2012 08 31 the rebalancing will take many years and has to be based on reforms of social security and pensions, so that people will dare to lower savings and increase spending.
To the Point (continued)August 31, 2012 How will China’s slowdown affect the rest of the world?Chart 1: Credit growth, reserverequirements in small and large banks, and Since about half of global growth comes from China alone, the effects on the worldlending and deposit interest rates in China economy from a Chinese hard landing would be substantial. Slower demand would affect not least exporting countries like Germany, Japan and Sweden, but also the US, 30 where foreign trade has become more important for growth after the financial crisis. 25 Another dimension is the effect on commodity prices. Steel prices have already Credit Growth/M2 fallen, and we see other commodity prices also being affected. For a deeper 20 discussion on commodity prices, read the July Swedbank letter on “Energy and Commodities”. The countries most dependent on Chinese demand for commoditiesPercent 15 are Australia, Indonesia, and Brazil. 10 Reserve requirements in small and in A third effect would be financial markets’ response to the slowdown. There are large banks banks expectations (and hope) that China will be able to withstand a hard landing, so that at 5 least the global economy can continue its slow jog forward, despite the US’s creeping Lending rate 6 months and the euro area’s shift into reverse. However, with China growing more slowly, Deposit rate 6 months 0 equity markets, especially, would become depressed. A Chinese hard landing, in 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 combination with fiscal cliff concerns in the US and a deeper crisis in the euro area Source: Reuters EcoWinSource: Ecowin would be particularly turbulent. A fourth effect of a Chinese slowdown would be on its relations with other countries. China has stopped the appreciation of the renminbi against the US dollar and instead allowed it to depreciate; this has given an opening for the US Congress toChart 2: House price development in characterize China’s exchange rate policy as manipulative. Not least, presidentialBeijing (l.h.s) and the Shanghai Stock candidate Mitt Romney has threatened to pursue this issue if elected. This could helpExchange (r.h.s) build up pressures for trade protectionism, not only between these two countries, but 25,0 13000 also between China and Europe, Japan, and emerging markets. Shanghai <-- House price 22,5 stock growth Beijing 12000 exchange, A fifth effect concerns the power shift this fall, as several members of the Politburo 20,0 180 index--> 11000 will be replaced. Moreover, in March next year Xi Jinping and Li Keqiang are 17,5 10000 expected to succeed Hu Jintao and Wen Jiabao as President and Prime Minister. If 15,0 9000 China’s growth is slowing more than expected, there are risks to political stability, and it may also be more difficult to reach a consensus on the needed policy measures.Percent 12,5 8000 Index 10,0 7000 Political instability could not only have severe effects on economic and social 7,5 6000 conditions for the population, but also have a large impact on foreign direct 5,0 5000 investment, especially on international firms already located in China. 2,5 4000 From a longer perspective, a slowdown and a attendant need to stimulate the 0,0 3000 economy could mean that the rebalancing process is postponed and that the risks for -2,5 2000 overheating increase, thus leading to a hard landing in a few years’ time, with much 05 06 07 08 09 10 11 12 bigger consequences for the world economy. This would be particularly difficult if Source: Reuters EcoWin China were to liberalise the financial sector in the meantime, and the contagion fromSource: Ecowin bursting bubbles in the financial and real estate sectors would be more widespread. In such a situation, the process of liberalisation could be reversed, thus leading to new regulations in various sectors. Our main scenario is that China’s GDP will grow by just under 8 % this year, before reaching 7.8% next year and 7.6% in 2014. This includes the authorities taking a cautious approach to stimulus, in order to avoid a new real estate boom and overheating. This scenario – although projecting slower growth than we have seen in the past – is a positive scenario for China in which the economy is landing softly, the policy response is moderate, and the rebalancing towards private consumption continues slowly. It remains to be seen if the scenario is not only positive, but also optimistic. As always, it is good to hope for the best and be prepared for the worst. Not least does this apply to China at this point. Cecilia Hermansson Economic Research Department To the Point is published as a service to our customers. We believe that we have used reliable sources SE-105 34 Stockholm, Sweden and methods in the preparation of the analyses reported in this publication. However, we cannot Telephone +46-8-5859 1000 guarantee the accuracy or completeness of the report and cannot be held responsible for any error or email@example.com omission in the underlying material or its use. Readers are encouraged to base any (investment) www.swedbank.com decisions on other material as well. Neither Swedbank nor its employees may be held responsible for losses or damages, direct or indirect, owing to any errors or omissions in To the Point. Legally responsible publishers Cecilia Hermansson +46-8-5859 7720 2