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By Andrew Kenningham, Capital Economics
Some investors think China’s economy will continue to boom; others that it’s about to collapse. Andrew Kenningham says neither is likely. China’s economy will probably continue expanding, but at a gradually slowing pace, he says.
China has again become a major economic power in one of history’s most spectacular reversals.
Its share of world gross domestic product (GDP) shot up from only 2 per cent in 1990 to 6.2 per cent in 2007. The global financial crisis largely passed China by, and it went on to reach 15 per cent of world GDP this year. Its share of world exports has risen even more rapidly, from only 1 per cent in 1990 to 14 per cent this year.
This exponential growth has been cheered on by western commentators, many seeing China as the world’s next economic superpower. But others warn that a big economic crisis is just around the corner. In my opinion, both of these views are exaggerated.
Fears of devaluation fade
The good news is that the risk of a crash, or a hard landing, is much lower than many fear.
Only two years ago, a currency ‘devaluation’ in China sent ripples around global financial markets and evoked memories of the great emerging-market crises in Thailand in 1997, Russia in 1998, and Argentina in 2002.
But China’s devaluation was barely worthy of the name. The yuan, or renminbi as it is also known, lost a mere 2 per cent of its value. The real problem was that policymakers in Beijing let people believe that they might want a much bigger adjustment.
It didn’t help that China was suffering from significant capital flight as Chinese companies worried that the currency may weaken.
Two years later, the situation is very different. Confidence has been restored. The central bank has been accumulating reserves and the value of the renminbi has actually risen against the US dollar by around 5 per cent this year. The People’s Bank has set out a clearer, more flexible exchange-rate policy.
Rising corporate debt
Not all the risks have evaporated, of course. China’s banks, and its growing shadow-banking system, have been giving ever-larger amounts of credit to companies and, increasingly, to households.
Excessive lending has been the root cause of numerous financial crashes throughout history – including of course the sub-prime debacle in the US. So these risks should not be dismissed lightly.
Indeed, all countries that have seen as large a rise in bank lending as China have subsequently suffered a crisis. Even the Governor of the People’s Bank of China, Zhou Xiaochuan, warned in October that the economy may be heading for a ‘Minksy Moment’, or credit crunch.
Forecasting financial crises is notoriously difficult, but there are reasons to think that the worst can be avoided in China.
For one thing, most of the companies and banks involved are state-owned and, as public debt is not particularly high, the state could afford to bail them out if it needed to. Also, the debts have not been securitised or sold to foreign investors – in contrast to the US sub-prime crisis – so there is less risk of problems spreading throughout the economy or beyond China’s borders.
Indeed, foreign involvement in China’s equity and bond markets remains very modest (and tightly regulated), and so does foreign-bank lending to China. So the international risks are not so huge.
How will President Xi use his power?
Journalists and political analysts agree that President Xi Jinping tightened his grip on power at the Communist Party Congress, which took place in October.
As such, he could choose to push through the reforms needed to sustain China’s economic expansion.
Top of the list are the closure of loss-making state enterprises, many of them in heavy industries such as steel or coal mining, and ending the practice of politically-motivated bank lending at low interest rates.
However, Xi has been at the top of China’s Communist Party for a long time but has not been a great economic reformer. He’s unlikely to change his tune now.
His lengthy report to the congress dwelt more on his anti-corruption drive, and military reform, than on the economy.
Growth to slow, but not collapse
Overall, I believe China’s economy will continue to slow, but only gradually.
For the rest of the world, the biggest effects may be felt in the market for commodities such as iron, copper, and aluminium. China accounts for half of global demand of these resources. Their prices are likely to fall.
China will continue to be a source of anxiety for investors because it is so large and difficult to understand. But otherwise, I think it is unlikely to be the cause of a major shock to global currency or financial markets in the next few years.
Devaluation: A monetary policy to lower the value of a country’s exchange rate, which is used by countries with fixed exchange rates.
Minsky Moment: A sudden collapse of asset values after an extended period of growth. The term is named after economist Hyman Minsky.
Securitisation: The pooling of debt, to onsell to a third-party investor, who recoups the interest and capital.
Shadow Banking: Non-bank unregulated financial institutions, providing credit and capital to borrowers and investors.