Chinese Economy shifts Gears

High Octane Chinese economy finally shifts a lower gear, and announced it GDP to 8% lower than what it was expected for the first time since China's boom started virtually everyone agrees that the double-digit, super-charged boom years are drawing to a close. Speculation over the possibility of a so-called "hard landing" for the country flourishes with each boom and bust cycle, only to die down as China's growth revs up again. This time, however, both external and internal factors - including global conditions, domestic politics and financial trends - are reinforcing the downturn. Many experts warn that without some painful reforms, there will be worse trouble to come. Still, economists' opinions about just how far China's economy will fall range widely. Also, exactly what constitutes a "hard landing" for a country that has until now been viewed as an almost unstoppable economic powerhouse varies from analyst to analyst, although most point to China's growth rate as a key defining factor. "People give different definitions," China's growth slowed to 8.9% in the final quarter of last year, after months of attempts by the government to cool inflation through curbs on bank lending, interest rate hikes and stringent increases in banks' reserve requirements. The government has said all along that it expects growth to slow: In his "State of the People's Republic" address to China's legislature on March 5, Premier Wen Jiabao set the annual growth target for 2012 at 7.5% -- the first time the official benchmark has been set below the 8% level long viewed as the minimum needed to create enough jobs and ensure social stability. And in the current five-year plan, the government has set the annual growth rate at 7%.

The next Middle East?

China's transition to an era of lower growth in some ways parallels Japan's abrupt shift in the early 1990s.
Both countries allowed excessively cheap, often politically influenced use of credit to create a massive bubble in their property sectors. But there is one key difference that could lead to ugly consequences in case of a hard landing, notes Wharton management professor Marshall W Meyers. "You still have a lot of poor people in China, many more than Japan in the 1990s. Japan was essentially middle class, with all [citizens] having medical
insurance and social security. That is where the political trouble is," Meyer says. Dissatisfaction over lagging incomes and inadequate social services could spiral if the growth that has underpinned Communist Party rule were to stall: "Neither China nor the world would like to see turmoil [in China] like [what we saw last spring] in the Middle East." Indeed, in mid-March, Premier Wen noted that if the country doesn't initiate key reforms, it could experience enough social unrest to precipitate another Cultural Revolution like the one that shook the country between 1966 and 1976 Through a slew of metrics, especially its voracious appetite for raw materials like aluminum and copper, it’s clear that China has some serious economic muscle.

Credibility Factor
Till now China was the only country whose credibility was virtually undoubted by all but now, many frontier economies have issued questionable statistics at some point. “It’s more of an art than a science in terms of digesting emerging-market data,” said Thin. Even some so-called modern economies have been caught red handed on this issue. Greece infamously lied to the world about its public debt as it attempted to gain entry to the now-reeling Eurozone. This disastrous downplaying of economic reality helped spark Greece’s debt debacle that could yet still bankrupt the country.
Kenny said, “If it can happen in Greece, in the EU -- the most regulated economy outside of a planned economy -- who is to say it can’t happen in a planned economy” like China’s?
And Greece’s 2011 nominal GDP of $305 billion is just a fraction of China’s $7.3 trillion economy, which is second only to the U.S.
Each time a new government takes control in Spain and Portugal they seem to “uncover” new evidence showing a deeper deficit than the prior government had acknowledged, said Thin.
Another example of data fudging is Argentina, which publishes inflation data that should make its economists’ pants light on fire. INDEC, the country’s official statistics arm, has been criticized for attempting to placate a population that knows a little something about hyperinflation.
“Misreported prices have cheated holders of inflation-linked bonds out of billions of dollars,” reads a February note in The Economist explaining why the magazine has decided to stop publishing INDEC’s figures entirely. “We are tired of being an unwilling party to what appears to be a deliberate attempt to deceive voters and swindle investors.”

Beijing's Balancing Act

Despite the myriad internal and external constraints confronting China's leaders, Beijing has various
Options for helping to shift the economy from an investment driven model to one fueled by consumer
demand. First, China needs to improve its allocation of resources to better balance the economy -- a step that only can follow reforms in interest rates and other pricing mechanisms. "China has all the wrong prices --including exchange rates, interest rates, gasoline prices and land prices. Those prices are all controlled and managed by the government. If you have the wrong prices, you will have wrong allocations," notes
China's handling of its 10.7 trillion RMB in local government debts is typical of this imbalance in the
economy. In early February, the central government asked Chinese banks to roll over local government
debts that accrued during the massive recession-fighting stimulus binge in 2009 -- essentially sweeping
them under the rug for a later reckoning. More than half of those loans are to come due over the next three years. By far, many analysts say, the biggest shift required is a redistribution of resources that will unleash the potential spending power of the Chinese public. "China needs to rebalance the composition of its GDP more toward consumption, develop a more market-based monetary policy, reduce the excessive privileges of state-owned enterprises, ease income inequality and focus on promoting more productive and environmentally friendly industries," according to Rob Subbaraman, chief economist with Nomura International in Hong Kong. Moving toward a more market-based monetary policy, involving a more International in Hong Kong. Moving toward a more market-based monetary policy, involving a more
flexible exchange rate and deregulated interest rates, would push bank deposit rates higher, helping to
reduce the need for saving and also improving investment options so that families do not rely so heavily
on real estate to grow their nest eggs. Meanwhile, the government needs to make the politically difficult
choice of reducing preferential treatment for state companies, which now includes preferential access to
bank credit and government subsidies of land, labor and electric power. The aim is "to redistribute income
from the corporate sector to the household sector," he says.
Subbaraman sees a one-in-three likelihood of a hard landing and believes China could resort to extra
stimulus spending to avert such a worst case scenario. But without the necessary reforms, the stimulus
money would just go to waste, he notes. "The key with future fiscal stimulus is to direct it more efficiently at consumption and more productive areas of investment."

Varun Kumar
Indian Institute of Information Technology