The Chinese economy is the topic of the new year. From Chinese President Hu Jintao’s state visit to the US to the World Economic Forum in Davos, the transformation of the world economy dominates the headlines, with developed countries burdened by massive government debt on one side and developing countries achieving impressive economic growth rates on the other.
Since the financial crisis some Chinese companies, supported by state-owned banks, have been slowly changing their export focus to business ventures around the world. In the Bahamas a major hotel resort development, the Baha Mar, is financed by a Chinese bank and constructed by a Chinese firm, and in the Cayman Islands a Chinese company is in talks with the government over several infrastructure projects.
At the Cayman Business Outlook in January, Anwer Sunderji, chairman of Fidelity Group, noted a relative economic decline and impoverishment of developed nations, which indicates that developing countries are catching up. To illustrate the point of China’s economic rise, he offered several statistics.
China’s impressive growth
Reflecting the significant investments the Chinese government has undertaken in its domestic infrastructure, Shanghai, the largest container port in the world, has more capacity than all the container ports in the US combined, he said. China has 13,000 miles of high speed train lines, more than the entire world’s and by 2020 China will have 50,000 miles of highway, more than the total interstates in the US, Sunderji added.
On the consumer side China also posts impressive numbers.
Mobile phone sales increased 57 per cent in 2010 with more than 246 million units sold, according to Beijing-based research firm Analysys International. By the end of 2010, the total number of Internet users in China reached 457 million, a 73 million increase over 2009. China is also the biggest car manufacturer in the world, producing 14 million cars per year.
Even in terms of absolute wealth, China is catching up. China currently has 189 billionaires according to the Hurun Rich List 2010, a number that increased from only 69 one year earlier.
All this is the result of an economy that managed to grow between 7 and 14.2 per cent per year since 1991.
This has left its mark on US citizens. In a Pew Research poll 47 per cent of Americans said that China is now the world’s leading economic power, compared to 31 per cent who believe the US is still number one. The results constitute a reversal of the findings of a similar survey only three years earlier.
An HSBC report, ‘The world in 2050’, predicts that by the middle of the century 19 of the 30 largest economies will be from countries that we now call “emerging”. China and India are going to be the largest and third largest economies in the world.
To a large extent this will be the direct result of the size of their population. HSBC believes demographics and ageing population will also be a factor for rich but smaller European countries, such as Switzerland, the Netherlands or Scandinavian countries, that are expected to drop out of the top 20 altogether.
However, by 2050 the seismic shift in the global economy will still only be beginning. Despite a seven-fold increase, income per capita in China will only be 32 per cent of that in the US, HSBC writes. Currently, China’s economy generates 9 per cent of the per capita income in the US.
And also in other areas China still has some ground to make up.
Although the world’s most populous country tops the world league for reading and maths scores among 15 year olds, while the US comes in 11th and 26th respectively, more than 25 per cent of Americans have a college degree, compared with 5 per cent of Chinese.
Americans can still expect to live on average five years longer than the typical resident of China, despite living in a country not blessed with longevity compared to the rest of the developed world.
China’s share of global private consumption is a mere 5.6 per cent, much lower than the 29.1 per cent for the US and 26.2 per cent in Western Europe.
Still, considering that China is quite some way away from reaching its full potential, it is already the largest market for consumer goods.
China’s changing role
Trade and economic growth statistics do underscore China’s greater weight in the world economy, but China’s role is also changing. Since the financial crisis the world has looked to China for growth and Chinese companies have used this period to grow larger and stronger and obtain new technology and resources around the world. As a result the developing world is exporting more to China.
China’s focus has shifted from an export-led model, in which China fuels its economic growth through exports to the developed world, to a model of intensified trade ties with the developing world.
Many observers say China is trying to reshape post-American globalisation, by trying to influence the rules, institutions and trade relationships that are at the heart of the global economy. While this may be the case, there is also a growing realisation in China that the reliability of the US as the buyer of last resort, ie the main buyer of Chinese goods, may come to an end.
The insecurity that this has created has led to a reorientation of Chinese commerce towards the developing world, in order to export and invest more reliably. Many of the resources and commodities that China needs, such as base metals or oil, are located in developing countries. At the same time many of these countries need capital, which China has in excess due to its trade surplus.
Some of the semi-monopolistic and state-owned Chinese companies, four of which (PetroChina, ICBC, China Construction Bank, China Mobile) figure in the top 12 of the world’s largest companies by market value, have grown to a mass that enables them to leave their home market, looking to acquire companies all over the world.
So while China is not yet ready to give up Europe or the US as major markets, the main thrust of its investment activity takes place in Asia, India, Russia, South America, Africa and the Middle East.
Chinese state-owned banks stand by to support this reorientation. In the past two years alone China Development Bank and China Export-Import Bank awarded $110 billion in loans to developing country governments and companies, a sum that exceeds the total lending by the World Bank.
The volume and diversity of overseas loans awarded by Chinese banks indicates that a new form of globalisation, driven by China, is emerging. The range of Chinese loans encompasses loan for oil transactions in Russia and South America, infrastructure projects in Africa and export supporting customer financing in India.
It included for instance a $10 billion loan agreement with Brazil’s Petrobas and a financing arrangement with India’s Reliance Power to purchase $10 billion of power generation equipment from state-owned Shanghai Electric. Closer to home in the Bahamas, China’s Export-Import Bank agreed to arrange $2.5 billion in financing and Beijing’s state-owned China State Construction and Engineering Corporation signed on as the general contractor and invested $150 million in the construction of Baha Mar, a vast hotel and casino resort.
Chinese investments in Cayman?
This raises the question when the first Chinese businesses and investors will touch down in Cayman? Cayman Islands Premier McKeeva Bush announced at the Cayman Business Outlook in January, that he is in talks with a Chinese company and short of signing a memorandum of understanding for the dredging of the North Sound and the provision of the necessary infrastructure to take full advantage of the channel from an economic perspective.
Other infrastructure projects that are being discussed with the so far unnamed Chinese company include the development of a pier and related facilities near to the Cayman Turtle Farm in West Bay, the development of a cruise pier and related facilities in Cayman Brac, major road works in the eastern districts of Grand Cayman and enhancements to the airports both in Grand Cayman and Cayman Brac.
Increasingly countries around the world are finding that their principal trading partner is no longer the US but China. As a result, the US is concerned over the expanding Chinese influence not least with regards to its own energy security. China, already the world’s largest polluter, passed the US as leading energy consumer in 2010, a decade earlier than previously forecasted. China consumed 2,252 million tonnes of “oil equivalent” last year, approximately four per cent more than the US, according to the International Energy Agency.
It is an open question whether China will ultimately ensure the stability of its energy supply routes, for example in West Africa and Asia, through its navy. This possibility has not gone unnoticed by China’s Asian neighbours and it is no coincidence that military spending in Asia is actually increasing.
Changing the monetary system
The financing of new and closer trade ties with developing countries will not only ensure Chinese access to much needed resources and bolster existing economic relationships, it also pushes for a new role of China’s currency in the international monetary system.
Chinese government officials have for some time expressed the view that the US, by controlling the world’s reserve currency, has an unfair advantage for its economic policies and would welcome if the Chinese renminbi eroded some of the importance of the US dollar in the international monetary system.
Too much, too fast?
However, this is still a long way off and not everyone believes that the Chinese economic miracle is going to continue without problems. In the last quarter of 2010 the Chinese economy expanded by 10.3 per cent, while the inflation rate increased by 4.6 per cent in December, putting inflation at 3.3 per cent for 2010, slightly over the 3 per cent target.
Daouki “David” Li, an advisor to the People’s Bank of China, says that the main challenge for China will be not to grow too fast. He argues that China needs to let its currency appreciate by about 5 to 6 per cent annually against the dollar to combat inflation and avoid fuelling asset bubbles.
Li forecasts a Chinese GDP growth of 9.5 per cent, despite a general change in Chinese monetary policy from loose to cautious. The consumer price index will reach between 3.8 and 4 per cent in 2011, he says.
According to Li, inflation in China is mainly the result of increasing production costs, rather than driven by demand, and therefore the lowering of production costs is more important than interest rate hikes to fight inflation.
Increasing Central Bank reserve requirements to constrain the robust bank lending of 2010 would therefore be the preferred tool, agrees HSBC economist Frederic Neumann, who says that hot capital inflows is one of the problems that China is facing. He points out that interest rate rises would signal that monetary policy is tightening. With the Federal Reserve pumping money into the US and global economy, such a move would draw in capital and negate the desired effect, he says.
This is direct result of the renminbi being a tightly controlled currency that is pegged to the US dollar and the financial markets seeing it as a one-way bet to appreciate in value, says
George Magnus, author of ‘Uprising: Will Emerging Markets Shape or Shake the World Economy’.
“As the Chinese state and its banks continue to accumulate a vast stock of US dollar reserves, monetary control is undermined, raising the threat of asset bubbles, and a major risk of financial loss arises from the eventual appreciation of the RMB,” Magnus writes.
Property and asset bubbles
Several economists argue that the Chinese economy relies dangerously on investments in real estate and construction, spending for which increased by 23.8 per cent in 2010.
The Chinese property market already bears all the hallmarks of a property bubble in the making. Since October the weekly transaction volume in the property market increased by nearly 100 per cent in 35 cities. Across 70 cities, property prices rose 6.4 per cent in December from a year earlier.
In January, the Chinese government therefore introduced several measures to fight rising prices in the property sector and prevent the property bubble from spreading to smaller cities.
The measures included an increase in down payments on mortgage loans for second-home purchases to 60 per cent from previously 50 per cent. Additionally, in all major cities home-purchase restrictions were tightened. Families with local-resident registrations in those cities are allowed to buy a second home, but can no longer buy a third property, while non-residents who own a home in those cities are not allowed to buy a second home. To curb speculative property trading, property sales already incur a 5.5 per cent tax, if the property is sold within five years after the purchase.
Chinese stocks meanwhile trade at two to three times the average price-earnings ratios of stocks in the developed world. Some investors explain this as a reflection of the upside potential of Chinese companies, whereas others say Asian shares are simply expensive.
With huge amounts of hot money entering Asia, there is a risk of an asset bubble building up.
“Sino-euphoria is having its day, but the combination of a credit and an investment boom is obscuring the causes of possible instability which lurk on the horizon,” concludes Magnus.
Tariffs, intellectual property theft, exchange rates
The artificially undervalued exchange rate of the renminbi in combination with a large Chinese trade surplus has been the topic of US-China relations for some time.
For years China was successful in keeping the value of its currency down, making Chinese exports to the US cheaper and US exports to China more expensive. Although the renminbi was allowed to modestly appreciate, by 3 per cent since the summer of 2010, this was hardly sufficient to change the situation.
For US exporters to China the exchange rate is not the only issue. Other Chinese protectionist measures include prescriptions that certain products not only have to be manufactured but also be designed in China. If foreign products are allowed to be imported, tariffs often erode what competitive advantage these goods might have.
The theft of intellectual property is also a concern for businesses in the developed world. For instance, China is the second largest market for computer hardware, but only the eighth-largest in terms of software sales, a situation that is difficult to explain without considering software piracy of massive proportions as part of the equation.
Future trade tensions with China might therefore be unavoidable.
Rebalancing the Chinese economy
China’s trade surplus also creates imbalances in the global economy. Michael Pettis, a professor at Beijing University, noted at the Cayman Business Outlook that China’s trade surplus has to be balanced by trade deficits in other countries.
Imbalances in the economies of the US and some countries on the periphery of Europe such as Spain are therefore directly related to the China’s external trade imbalances. By the same token, Pettis says, lowering the trade surplus in China would also resolve some of the issues in the rest of the world.
However, China only has limited options to achieve this. Any measure would have to be introduced gradually and it is very likely that these measures will be taken far too late, Pettis says.
In 1990, when Japan had a share of 17 per cent of the global economy and impressive growth rates of 8 to 10 per cent for over two decades, hardly anybody would have predicted that Japan’s growth rates would struggle to achieve an average of 1.1 per cent for the next two decades.
China, Pettis argues, has followed the Japanese growth model of low domestic consumption, an undervalued currency and a large trade surplus. Every time in history a country followed this trend, an initially impressive economic boom was followed by a lost decade, he says.
Although the current growth model has served China well in achieving massive growth rates, at some point the economy will need to be reshaped from an over-reliance on exports and overinvestment to support jobs in the export sector and more “attention will have to be given to ways of supporting a rising share of consumption in total GDP and greater production of goods and services aimed at realising this goal”, says Magnus.
China’s leadership is well aware of the need for an economic rebalancing. In particular the record low share of domestic spending of the GDP of 36 per cent in 2010 is a major worry. Increasing household income, however, is not straightforward.
Increasing wages puts into question the competitiveness of Chinese companies, which are “addicted to low wages”, says Pettis. Increasing the exchange rate, and making imports cheaper in the process, could also stifle the economy, if done too quickly. And raising interest rates, which would reward households as net savers, will increase government debt, particularly as Pettis believes that government debt in China is much higher than the typically reported 20 per cent.
According to Pettis, the result will be that all these measures can and will eventually be taken by the incoming leadership in China, but they will slow down growth much more sharply than expected. This slowdown may not necessarily be bad for China, he believes.
“If there is a serious attempt at rebalancing the economy by raising wages, interest rates and the currency, China can manage a much slower GDP growth rate while still maintaining a high growth rate in household income and consumption.”
Others are less optimistic amidst the general admiration for Chinese growth.
Daniel Altman, founder of the consulting firm North Yard Economics and an instructor at New York University’s Stern School of Business, boldly claims in his latest book ‘Outrageous fortunes’ that China is not likely to overtake the United States as the world’s leading economic power.
He points to a still hierarchical culture, corruption and lack of a first-rate technology infrastructure and highlights that China is not supportive of start-up businesses. Moreover, the “one-child policy” reduces China’s population growth to less than 0.7 per year, making China the fastest ageing country in the world.
By 2050, China will have hundreds of millions of senior citizens, and average incomes will grow at lower rates than in the US. China’s moment in history “will be impressive, but brief”, Altman believes.