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SPEAKING FREELY
From Great Leap to soft landing for China
By Mark A DeWeaver
Speaking Freely is an Asia Times Online feature that allows guest writers to have
their say.
Please click here if you are interested in
contributing.
A saying dating back to the days of the planned economy has it that Chinese
macroeconomic policy follows a cycle: "Once policy is relaxed, there is chaos;
once there is chaos, policy is tightened; once it is tightened, people
complain; once they complain, it is relaxed; once it is relaxed, there is
chaos." (Yi fang, jiu luan; yi luan, jiu shou; yi shou, jiu jiao; yi jiao, jiu
fang; yi fang, jiu luan.) In the most recent cycle, China had
relaxation in the form of fiscal stimulus after the 1997 Asia crisis, followed
by a chaotic period of overinvestment in 2003 and early 2004. This precipitated
the People's Bank of China (PBoC) interest rate increase of September 2003 and
restrictions on lending and land use in April 2004, which resulted in plenty of
complaints by enterprises and local governments that felt growth should be
faster. Now, after almost two years of tightening, could it once again be time
for the relaxation phase?
The current tightening cycle is the third in the past 20 years. It is
noteworthy that the previous two had to be continued for multi-year periods
because of the threat of out-of-control money supply growth and inflation. Both
also ended double-digit GDP growth and were followed by multi-year growth
recessions. Typically, the tightening phase has lasted a lot longer than the
"chaos" that preceded it.
The first of these tightening cycles began in 1985, after economic
liberalization in the previous year led to rapid growth in investment,
consumption, and money supply. As in every cycle, including the present one,
administrative measures were the government's primary tool for macroeconomic
management. The authorities initiated a variety of policies to slow the
economy, including restrictions on projects outside the state plan, limitations
on state enterprise salary increases, and minimum capital requirements for
borrowing by township enterprises. In March, 1985, with M2 growth at 40% and
inflation at 7% and rising, the PBoC also raised deposit rates by 108 basis
points (from 5.76% to 6.84%). (M2 is a broad measure of the money supply that
includes commercial bank reserves, cash in circulation, and demand and savings
deposits.) Both administrative and monetary policy stayed tight for the
following five years, as M2 growth remained above 20% until the first quarter
of 1989 and inflation rose to a high of 28.4% before finally falling below 5%
in January, 1990. Interest rates peaked at 11.36% in February 1989 and were not
lowered until March 1990. GDP growth fell from a high of 16.5% in 1984 to a low
of 3.8% in 1990.
The second tightening cycle followed the boom of 1992-1993, when a new era of
market reforms and financial innovation (much of it unauthorized) began after
Deng Xiaoping's famed January 1992 "southern tour". This time the
administrative measures focused on excess speculative liquidity: bank loans to
property developers were withdrawn, mortgage lending was suspended, and
investigations were launched into widespread misappropriation of state-sector
funds (for example, funds allocated for grain purchases that had found their
way into Shenzhen real estate projects). The PBoC began raising rates in April
1993, with M2 growth at 51.9% and inflation at 12.6%, and the tight money
policy continued for the next three years. M2 growth was above 30% for all but
two quarters until the end of 1995, and inflation did not fall below 10% until
January, 1996. GDP growth fell continuously during this period, from 14.2% in
1992 to 7.2% in 1999.
As the current tightening cycle will be only two years old in September (if we
date its beginning from the interest rate rise of September 2003), you might
conclude from these precedents that it would be at least another year before
policy was likely to ease. GDP growth, which fell for six to seven years
following the earlier tightenings, might be expected to decline for at least
another four years. And if the extent of the decline were comparable, by the
end of the decade the growth rate would have fallen to 5% or less.
But the present situation differs from the previous two cases in ways that make
such an extreme outcome seem unlikely. The most noticeable differences are in
money supply growth and inflation, which have been quite subdued by historical
standards. So far in this cycle, M2 growth hasn't risen much over 20% (the most
recent peak was 21.6% in August 2003), and inflation peaked at a mere 5.3% in
July 2004. In addition, GDP growth has been below 10% since peaking at 10.3% in
the first quarter of 2003 and consumption growth has been moderate as well
(13.2% in the second quarter of this year). And while previously there was
pressure on the currency to depreciate, this time the opposite is the case.
As the problem faced by the policy makers is much less severe this time, will
the austerity program required to solve it be shorter and less extreme than its
predecessors? Recent macro data as well as statements by policy makers suggest
that this may well be the case. Growth in fixed asset investment, the only area
in which there was any serious overheating, has been below 30% for the last
five quarters (25.4% in the second quarter of this year). This is still high
but much less alarming than the 43% reached in the first quarter of 2004.
Meanwhile, M2 growth in recent months has fallen even below the levels of the
deflationary period of 1998-1999, while inflation of only 1.6% in June has led
many commentators to wonder whether another such period may again be at hand.
In fact, there are signs that the threat of a recurrence of deflation is now
the main concern of both of the primary government organs responsible for
macroeconomic policy - the PBoC and the National Development and Reform
Commission (NDRC). (The NDRC, as the State Council's macroeconomic policy arm,
has primary responsibility for the administrative aspects of the austerity
program.) An article in the July 18 online edition of the 21st Century Business
Herald (one of the mainland's leading business newspapers) cited a participant
in the June 29 PBoC Monetary Policy Committee meeting who said the members had
concluded that the main question is now "whether or not the economy will cool
too much" (jing ji hui bu hui guo leng). The article also cited a July
13 report of the NDRC Macroeconomic Research Institute predicting a slowdown in
the second half of this year, in contrast to previous reports that had focused
on the need for continuing austerity. The report recommended expanding the
money supply to avoid "excessive adjustment" (guo du tiao zheng):
specifically, raising the target for M1 growth from 10% to 13%, and for M2
growth from 14% to 16%.
Chen Dong-qi, deputy director of the NDRC Macroeconomic Institute, gave a
similar assessment in an article posted on the China Economic Information
Network website on July 12. He cited three risks to the Chinese economy: (1)
slowing world economic growth, (2) a possible slowdown in consumption spending
if mainland property prices fall or world oil prices stay high, and (3) slowing
investment in the non-state sector. He expects somewhat slower growth for the
next two years and recommended that monetary and fiscal policy should be more
accommodative.
In the cover story of the July issue of China Finance (a publication of the
PBoC), People's Congress Political Consultative Conference standing committee
member Wu Jing-lian also expressed concern about excessive tightening. Citing
the risks associated with excess capacity, he opined that it is "entirely
possible" that the economy could take "a sudden turn towards deflation" (tu ran
xiang tong suo). His policy prescription is to get prices right by
eliminating subsidies that have led to excess investment, rather than relying
on the methods of the planned economy.
Indeed, the PBoC's first half report, (released on July 14) shows monetary
policy is already somewhat more accommodative. The report showed year-on-year
growth in Chinese M2 for June of 15.7%, an increase of a full percentage point
from the May number. Having declined from a high of 21.6% in August 2003 for
most of the months to October 2004, when it reached a low of 13.5%, this
indicator is once again clearly trending up. Growth in lending by financial
institutions was also up 13.3% in June (after falling continuously for the
previous five months), up 0.9 percentage points from May, though still down 3.1
percentage points from the previous June. Encouragingly for those who favor a
looser policy, the report found that this loan growth was "reasonable" (he li)
and that financial flows (jin rong yun xing) were "stable" (ping wen).
Of course, even with an easing of the austerity program, it is not a forgone
conclusion that a sharp slowdown can be avoided in the second half of this
year. Excess capacity, falling corporate profits, and bank capital adequacy
problems will continue to have deflationary effects, and more expansionary
fiscal and monetary policy may prove insufficient to counter them. (The recent
2.1% currency appreciation seems too small to have a significant effect one way
or the other.) If more pessimistic forecasts are correct, GDP growth will fall
by more than a percentage point from its second quarter rate of 9.5% to 8% or
below in the last two quarters of this year. But, if policy eases, stable
growth seems a more likely outcome. Investment will be supported if many of the
projects suspended last year are restarted; exports should continue to be
strong as long as the US economy remains healthy; and, since there was never a
"takeoff" in consumption expenditure, this sector does not appear to be at risk
of a "hard landing".
Ever since the Great Leap Forward of 1958, China's economic history has been
one of booms and busts. Under the planned economy, the cycle was dominated by
ideological movements emanating from the central government; in the '80s and
'90s, overinvestment at the local government and enterprise level was followed
by austerity measures imposed from the center. Both in 1985 and 1993, the
stated goal of austerity was to produce a "soft landing" - controlling
inflation without a large drop in GDP growth - but in both cases the policy
resulted in a prolonged slowdown instead. Given this poor track record, it
would be surprising if this time were different, but today's inflation rates
are so low that policymakers have considerably more room for fine-tuning than
has been the case in the past. While it is still too early to say what kind of
landing there will be, the pilots' chances seem much improved since the last
time this maneuver was attempted.
Mark DeWeaver worked as a research analyst in Shenzhen, China from 1991
to 1995, first for W I Carr and later for Peregrine Brokerage. He now manages
Quantrarian Asia Hedge, a hedge fund
investing in Asian equities. He can be reached at deweaver@quantrarian.com.
Copyright (c) 2005 Mark DeWeaver. Used by permission.
Speaking Freely is an Asia Times Online feature that allows guest writers to have
their say.
Please click here if you are interested in
contributing. |
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