The challenges for China

16th April 2012

The Reuters analysis piece said: "Shifting the yuan trading rules is about the strongest signal Beijing could give that growth downside has diminished and potential pitfalls are manageable. Few reforms are as replete with risk as tinkering with the currency because faith in its soundness directly correlates to economic stability."

Reuters' theory did not meet with universal approval from the increasing number of China bears lurking on the web: breezinthru on the comment boards wrote: "I think that the opposite is true, that China is terrified of the prospects of a hard landing and the directors of China's economy subscribe to the theory of adaptive expectations. With worldwide demand for China's exports in a worrisome, protracted slump, leaders tried to create enough demand within their own economy to avoid an economic disaster. The attempt was marginally effective, but it has fallen short of what was required."

But the momentum was with the China bulls. This blog on the FT's ‘beyondbrics' said: "Within hours of the release Nomura's Zhang Zhiwei decided to up the bank's annual growth forecast for the year, and withdraw his call for a rate cut. He described Q1 as the "nadir" for Chinese growth. HSBC said the economy would bottom out in Q2, while Citi said the rebound would come in Q3 at the latest."

Age Olav Mariussen from the community pointed out that, "unlike some other governments, the Chinese still have the firepower to increase consumption."

Edmund Harriss, Asian investment specialist at Guinness Asset Managers says: "When we look at economic growth figures in coming quarters and years, we are not looking for the headline number and whether it is above or around the ‘magic' 8% level, but rather the dynamics of that growth. We look for increasing evidence of household consumption, looking at additional data showing evidence of rising retail sales and lower precautionary savings. We also look for signs of stronger growth in the tertiary, or services, sector which employs more people than heavy manufacturing."

These figures showed the main growth driver in the quarter was consumption, which may ultimately be more important than the headline growth figure. Retail sales were up 11 per cent. While a quirk of the figures means that this does include some government spending, it is clear that the Chinese have been buying more furniture, which fits with a pickup in housing transactions.

The emergence of the consumer class is now a reality: The Atlantic suggests that the growing middle class in China represents a ‘real great leap forward' for the global economy as well as for China itself: "China faces huge challenges in its leap from being a low-income (but fast-growing) economy to a middle-income one. As wages rise, price levels will rise and China will lose some of its advantages selling cheap goods. That might be a dangerous prospect for Beijing, but it's good news for Chinese workers and good news for the rest of the world too. If China's middle class can buy more stuff with a stronger currency, it will create a massive new market of middle-income buyers on the global stage." 

However, before Chinese policymakers start patting themselves on the back for a job well done, there is the elephant in the room of the forthcoming change of government. This piece highlights the potential impact: "The sheer size of China's economy is so large that any policy change due to leadership reshuffling may have a global rippling effect.  Furthermore, this will only be the second time for a peaceful transfer of power to take place in the history of the CCP, if indeed the transfer happens as it has been arranged." 

It adds: "The upcoming CCP National Congress may not be as smooth and triumphant as the top leadership has hoped for.  The question of who will be able to become members of the Politburo Standing Committee may not be easily settled.  Xi Jinping and Li Keqiang may be "allowed" to become general secretary and premier, as any change there may create an unforgivable sense of political instability in China."

The short-term implication of the change may be some politically-driven loosening of monetary policy. This could provide an immediate boost to the economy, but the longer-term consequences may not be as positive. For the time being, a hard landing looks unlikely, but the political situation could ultimately be destabilising.

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