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China’s growth story due for reality check

Business Times – 11 Mar 2008

Country may face headwinds of a US recession as its stock market, property sector cool

THE beginning of Wen Jiabao’s second term seems remarkably similar to his first. In 2003, when Hu Jintao and Wen Jiabao, first took the helm as president and prime minister respectively, they were tested by the Sars crisis.

The pessimism of those like Gordon Chang in The Coming Collapse of China was at its peak. But Mr Hu and Mr Wen weathered that crisis and turned in the best five-year term performance in recent memory.

In 2007, China’s GDP reached RMB24.66 trillion (S$4.8 trillion), an average 10.6 per cent annual real growth from 2002 to 2007. In 2007, Germany defended its position as the world’s third largest economy only by a 2 per cent margin (higher than China) measured by daily-weighted exchange rate.

Also in 2007, China replaced the United States, becoming the world’s second largest goods exporter, next only to Germany. By the end of 2007, China’s foreign currency reserves ballooned to US$1.53 trillion, ranking it first in the world, 5.3 times more than at the end of 2002.

This time, when Mr Hu and Mr Wen are about to start their second term in January, China was plagued by a massive snowstorm and they weathered that too.

While many have doubts about China’s infrastructure quality and crisis control system, I simply cannot think of any other country that could have done a better job at a time when the worst snowstorm in half a century coincided with the Chinese New Year and millions of people were trying to get back home for family reunions and then go back to their places of work within the space of a few weeks.

According to Ma Kai, director of National Development and Reform Commission, China’s planning agency, from Jan 23 to March 2 – a span of 40 days – 196 million people travelled by railways and many millions by road, while the snowstorm almost paralysed the entire transportation network in many parts of China.

The 2003 Sars crisis and the 2008 snowstorms demonstrated China’s ability to overcome any shortlived crisis.

But for Mr Wen, there are much tougher challenges ahead in the first year of his second term. On March 5, at the first session of the 11th National People’s Congress (NPC), Mr Wen set China’s 2008 growth target at 8 per cent. Mr Wen’s 8 per cent target surprised none as this figure has been the regular target in the past few years. It basically comes from the 7-8 per cent long-term growth target which will quadruple China’s 2000 GDP by 2020.

In 2007, when the official target was set at 8 per cent, the real outcome was 11.4 per cent, a 13-year high. But in 2008, China could be nearer to the 8 per cent target.

The first challenge is obviously the US, one of China’s major export markets. In 2007, according to the US official figures, China replaced Canada to become the largest source of imports to the US valued at US$321.5 billion.

But the American economy may be in recession. And many economists wonder how serious it will be and how long the recession will last.

The US has a savings rate of virtually zero; its consumption was supported by an illusion of wealth.

But now more and more Americans owe more in mortgages than the real (current market) value of their homes. Worse, these people are about to pay more on their mortgages, as preferential rates come to an end. Delinquency and foreclosures can be expected and property prices will further drop, thus triggering a vicious cycle.

Some might argue that so far macro economic data only shows signs of a slowdown, not a recession. But you can really get a sense of economic fear from one person – Ben Bernanke, the Fed chairman.

In January, after having said that the sub-prime crisis was ‘containable’ for months, the Fed cut benchmark interest rate by 75 basis points (the biggest move in 23 years) just eight days ahead of a scheduled meeting. And on March 4, Mr Bernanke further urged banks to forgive a portion of mortgage principals.

As many pointed out, unlike the 2000-2001 US recession which was corporate dominated, this recession will be consumption led and therefore will have a much bigger impact on China. At the same time, the prospects for European Union, another important exports market for Chin a, will certainly not be as bright as it was. Facing domestic difficulties, the western world is very likely to practice protectionism and China may become its biggest target.

I project the contribution of net export to China’s GDP growth will be substantially lower this year than 2007.

As well, we are also witnessing the bursting of China’s own asset bubbles. On March 7, Shanghai Composite Index, covering both A and B shares listed on Shanghai Stock Exchange, closed at 4300.5, 30 per cent lower than the 6,124 historic high on Oct 16, 2007. At the same time, property, another bubble no smaller than the stock market, by and large remains intact.

Housing bubble set to burst

You might think that with improving living standard and fast urbanisation, the demand for property is huge in China. But the price is still be the biggest problem. People always see the booming  economy as the reason for a bull stock market, yet it is valuation that you have to look at the end of the day.

For a young couple with a combined monthly salary RMB 15,000 (the salary for fresh graduate is only about RMB 2000-3000), the price of a 70-year tenure apartment with a gross floor area of 120 square metres in a relatively good location in Beijing is equivalent to their 10-year combined salary. While the prices in second tier cities are lower, so are people’s wages.

At the same time, property has been playing a very important role in boosting the economy. In 2007, Chinese invested RMB 2854.3 billion in property, 32.2 per cent higher than 2006, accounting for about 25 per cent of China’s fixed asset investment in urban centres. It is also a hot spot for foreign investment. In 2007, utilised foreign direct investment (FDI) in real estate reached US$17.1 billion, more than double the figure the year earlier. It accounted for 22.7 per cent of China’s total utilised  FDI (excluding the financial sector).

But there are signs that the bubble is beginning to burst. Property brokers felt the pain first. Several high profile brokers have collapsed due to being overstretched and, more importantly, the reduced number of transactions.

Wang Shi, chairman of Vanke, the biggest listed property company in China, said earlier this year China’s property market had reached a turning point. Indeed, Vanke has started to offer price discounts for its housing projects in Guangdong, Chengdu, Shanghai and Beijing.

The world has witnessed a property boom in the past decade, and the collapse of the US housing bubble could trigger the falling of dominoes worldwide. The psychological impact of the collapse of the US property market on China cannot be underestimated. And measured by the relative values (and, in some cases, in absolute value), China’s property prices are even higher than in the US market.

Those who proclaimed ‘We are different’ as far as the stock market was concerned, have finally seen the law of gravity take hold. The property market is very likely to follow suit at some point.

When the bubble does burst, China’s investment growth will slow down greatly as it will influence not only property, but also the steel and the construction materials sector as well. Consequently, the country’s GDP growth will be further reduced.

Probably, China’s GDP growth will fall below 9 per cent this year, for the first time in seven years. But it is still a decent figure compared with the rest of the world.

The slowdown in the country’s exports growth should be a good reminder for China to attach more importance to how to improve product quality and add more value to its products. For instance, in 2007, China exported US$44.1 billion worth of steel products, which was the fourth most important export item by value. For a country facing growing resource shortages and environmental problems, to export steel products rather than more cars is stupid.

And more affordable housing generally will certainly better fit into Mr Hu’s ‘harmonious society’ concept.

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