Hard-landing fears misplaced

By Mark Williams (China Daily)
Updated: 2011-05-31 15:01
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China's economy may be the second largest in the world. But the Chinese economy, as financial markets see it, can still change direction with dizzying speed.

A few weeks ago, many commentators seemed to believe that the People's Bank of China, the country's central bank, was reacting too slowly to signs of the economy overheating. Now, after a run of weaker-than-expected data, many are worried that the pace of growth is already in rapid decline.

Certainly, there has been a shift since the start of the year. The push that the government's stimulus package gave to industry has subsided. Similarly, as incentives for consumers began to be withdrawn at the end of last year, the momentum of household spending started to slide. On one closely-watched measure, household spending is now growing at the slowest rate in nearly seven years.

But some perspective is needed. The evidence shows that economic activity has been slowing gradually, not falling off a cliff. If circumstances remain as they are today, China's economy will still grow by 8 to 9 percent this year and next. That may disappoint some, but it is hardly a disaster.

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Pessimists point to two risk factors with the potential to turn a benign slowdown into a hard landing. The first is the power shortage which has spread in recent weeks and which some in the power industry are predicting will be the most severe since 2004.

But there are important differences between 2004 and today. Seven years ago, China had simply run out of generating capacity. The lack of power stations was an insurmountable short-term constraint. The number of power stations, however, has increased hugely since then and the industry today has ample spare capacity.

The major issue now is that power producers cannot generate profitably, given high coal prices and capped electricity tariffs, and so have cut electricity supply. As a result, the government has choices if power shortages threaten to cause macroeconomic pain. It could offer subsidies to power producers to cover their losses. It could allow electricity tariffs to rise. The second of these may be unpalatable today because of inflation concerns. But perhaps that won't be the case for long. It looks increasingly likely that inflation will decline through the second half of this year.

In any case, power shortages have been reported to a greater or lesser extent in most years without causing widespread disruption. Many enterprises are able to fall back on their own diesel generators to keep operations running. Back in 2004, the economy sailed through power interruptions and still managed to notch up double-digit GDP growth.

The second concern is that property construction could slump. A wave of newly-completed property is set to enter the market in the coming months, which could dampen developers' appetite for new projects, particularly when policies implemented over the past year to slow price rises remain in force.

There is no sign of any slowdown in construction activity yet, perhaps because government efforts to increase the supply of affordable housing are offsetting a slowdown at the market's higher end. More generally, the risks of a crash, as opposed to a cyclical slowdown, have diminished as property price inflation has slowed to single digits compared with double-digit growth in average wages.

In sum, fears that China faces an imminent hard landing are almost certainly misplaced. The recent slowdown nonetheless illustrates some important and potentially worrying trends. Most obviously, China's economy and its demand for resources should not be expected to grow forever at the rates of the past few years.

Less appreciated are the challenges that China still faces in navigating a smooth passage in the years ahead. These may not trigger a sudden hard landing but could result in a prolonged period of disappointing growth. For example, the weakness of consumer spending in the last few months underlines that the economy continues to be reliant on investment.

Indeed, a final reason to believe China can avoid a sharp slowdown in the near term is that, with inflation likely to be falling soon, the government will have room to loosen its policy, if needed, in the second half of the year. Loosening would probably take the form of stronger lending by banks, further entrenching investment as the key driver of growth.

The risks associated with investing an ever-larger share of national income are growing. Enterprises invest to be able to sell more in the future at home and/or abroad. But if, in the long run, consumer demand does not grow as rapidly as output, then those enterprises will struggle to survive. Industry will be left with overcapacity and banks will find themselves sitting on a pile of unrecoverable loans. Either outcome would hobble broader economic growth.

Relying on foreign consumers is not a realistic long-term plan. That's why the government agreed long ago, at least in principle, that more must be done to encourage Chinese consumers to spend. Rebalancing has been a central policy objective for a while and is the key theme of the 12th Five-Year Plan (2011-2015).

But the government seems to be struggling to realize that goal. The share of overall spending in China coming from households has fallen without a break for 10 years, and continued to fall while the 12th Five-Year Plan was being drafted. If China fails to make a start on rebalancing soon, there is a rising risk that its growth will slow down much more than generally anticipated in the years ahead.

The author is a senior China economist at Capital Economics, a London-based independent macroeconomic research consultancy.