Is The Chinese Economy Overheating

Updated: Sep 30 2003, 05:30am hrs
Every now and then, non-Chinese academics and international analysts fret about China. Remember a year and a half ago, when there was a huge controversy regarding whether China was systematically overstating its level of GDP as well as its growth rates And how, for a brief while, some Indian economists and policy experts took great comfort in quoting these lower estimates to publicly claim that the Chinese economic miracle was not so great after all

These days, there is again a worry about China. Heres what some economists and analysts have begun to say: Driven by excessive investment, the Chinese economy is overheating. Investment in fixed assets accounted for 42 per cent of Chinas GDP in 2002. By the end of 2003, this is expected to rise above 45 per cent which would make it larger than even the share of private consumption expenditure. And with the country determined to make the 2008 Olympics in Beijing a spectacular success in all aspects, it seems unlikely that this investment boom will peter out for the next four to five years.

The implication of this rapid growth of investment is that capacity is going on-stream at a rate faster than consumer demand and looks as if it will continue doing so for the next few years. The denouement, according to doomsday economists and analysts, has to be an eventual deflation. Nobody is willing to predict when, but the pessimists are sure that it will happen sooner rather than later.

Worse, it is being said that before the deflation, China will see a huge investment triggered asset price bubble, and its consequent inflation. Why Because money supply growth in 2003 has already crossed 20 per cent, which is way above the 15 per cent growth that occurred in 2002. Moreover, much of the investment in infrastructure and basic industries has been financed by credit growth which, if properly estimated, could be as high as 35 per cent. So, before the fall, there could well be a situation of too much money chasing relatively lesser goods leading to an asset price bubble and inflation. In short, an artificial high and then a serious crash.

The naysayers go even further. According to them, Chinese mandarins are not terribly adept at fine-tuning the financial sector to slowly bring down the growth of investments and soft land the economy. While the Bank of China has raised the reserve ratio requirement by one percentage point, analysts consider this insufficient to cool over-investment. Besides, they argue that despite the huge stock of bad loans, the incentive system in the four main state owned banks in China is still biased in favour of pushing loans especially for projects undertaken by provincial and local government authorities. It is believed that unless the central government applies the brake and initiates tough financial sector reforms, Chinese bankers will continue to increase the size of their loan books and thus fuel the asset bubble.

So, should we in India be looking at a Chinese crash I dont think so, at least of the next five to six years. Let me explain why.

First, until the 2008 Olympics, China is going to push infrastructure and basic industries in a very big way. Making an international success of the Beijing Olympics is only one reason. A more important one is employment creation. Chinas population is still growing at slightly over 1 per cent per annum, which means that over 15 million people will continue to enter the labour force every year over the next decade. With the decline in fortune of many state owned enterprises, China desperately needs to create avenues for gainful employment, especially in the interior provinces. It is bad economics and worse politics to have several million unemployed streaming in from western parts of China to the south and the eastern seaboard in search of employment that isnt there to be got.

Second, much as the US Treasury Secretary John Snow might wish otherwise, China isnt going to let the renminbi appreciate. At most, it may gradually come around to a plus-minus 2.5 percentage point intervention band, within which the exchange rate can move like a snake in the tunnel. Keeping a lid on the exchange rate is critical for exports; and since Chinas growth depends a great deal on exports, you cant expect it to slit its own throat to please the US and the EU. The more OECD nations pressurise China to float the renminbi, the more recalcitrant it will get.

Third, while the Chinese government is well aware of the magnitude of bad loans, it cant afford to suddenly choke off credit flows for infrastructure, especially in the interior provinces, by financial sector shock therapy. Over the next four to five years, China will very gradually reform the banking system through a combination of carefully calibrated re-capitalisation and bad loan provisioning. The objective would be to slowly clean the bad loan book, without seriously affecting future credit flows. I dont expect a hard budget constraint coming from the banking sector.

Fourth, in all likelihood, the central government in China is not going to rein in its fiscal deficit. Today, it stands at 2.9 per cent of GDP. Given the need for infrastructure and employment creation, I suspect that this deficit will continue even marginally widen right up to 2008.

We can, therefore, be looking at a number of asset price bubbles, especially property values in important cities like Shanghai, Shenzen, Beijing and so on. We might also be looking at a slight increase in consumer price inflation from the current level of under 1 per cent to something like 2.5-3 per cent three to four years from now. But we are not looking at an imminent deflation, as the doomsday analysts seem to suggest.

What, then, do the numbers suggest Between 2003 and 2008, expect Chinas GDP to grow by an average of 7 per cent per year. That would translate to a GDP of $ 1,754 billion (at constant 1995 US dollars), and a per capita GDP of almost $ 1,300. If, over the same period, India grew at a creditable rate of 6.5 per cent per year, our GDP would be $ 726 bn and per capita GDP $ 635. In other words, the Chinese economy would be 2.4 times our size, and its citizens, on average, twice as prosperous. So, even if Chinas economy were to deflate in 2009, it would still be a long, long way ahead. Instead of pondering Chinas possible economic downfall six years from now, can we think of how to achieve our growth today

(The author is the Chief Economist of CII. These views are personal)