The Chinese economy gives some (partly) new worries

October 19th, 2018

In my last blog, I defined and discussed some different kinds of conundrums one can find in the Chinese economy. Unfortunately, I have to add a partly new one only a few days later.

GDP growth in Q3 as expected

Sure, I noticed this morning that Chinese GDP growth during the third quarter still was officially on track (6.5 percent yoy). But we know that Chinese exports these days are confronted with U.S. protectionism and that investments in construction have been cooling down more lately.

We also know that China still is working on its important objective to double GDP per capita between 2010 and 2020. In 2021, the Communist Party will celebrate its 100th anniversary – and certainly success stories have to be presented.

Meeting this long-term objective requires a GDP-growth rate at around 6 1/4 percent on average until 2020. This is one of the reasons why China’s insufficient GDP statistics simply have to show GDP growth above 6 percent. Another reason is to demonstrate growth stability which is clearly underlined by extremely small official growth fluctuations – actually limited to 0.2 percent maximum yoy in a dozen consecutive quarters.

I think no other country in the world has such a track record. Officials explain that phenomenon by pointing at China’s unique economic stability in all general terms. However, economic stability cannot be expressed well by even stable Chinese numbers for GDP-growth during so many quarters. Reality looks differently.

Some shift in economic policy

As a consequence of obvious growth concerns – which by the way also are expressed occasionally by officials, directly or indirectly – some (slight?) shifts in economic policy currently can be watched.

More focus is now put again on what economists call the demand side of the economy compared to some programmatic priority of the supply side since the Communist Party’s Third Plenum in 2013. Monetary policy is currently easened by lowering the banks’ cash requirements in the People’s Bank of China and, thus, give more room to new credits – despite the big debt problem. Fiscal policy is also put on a (somewhat) more expansionary track, meaning altogether more growth stimuli than before.

This – at least somewhat – revised economic policy stance could lead to delayed structural reforms which by definition would not be favorable at all.

However, the Chinese define demand and supply side policy somewhat differently from what we are used to in our part of the world. More supply side policy means in Chinese terms rather to provide the Chinese people and Business China with more and better goods and services that are needed for consumer satisfaction and modern corporate demand; the latter alternative could also mean cuts of industrial capacity to give a more balanced supply in line with market economy principles.

Supply side policy according to Western textbooks, however, is more concentrating on giving incentives to private households, companies and municipalities in order to, for example, save more, work more, increase personal flexibility on the labor market, learn more, give more education to the corporate staff, to increase R&D, to invest more, etc.

Watch the priorities of economic policy!

Only regularly updated knowledge about Chinese priorities in economic policy provides a reasonable chance to single out where Chinese economy may be heading in the medium and the longer run. The analysis of China is indeed difficult.

Today’s conclusion: Do not focus too much on Chinese GDP numbers!

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University
Editorial board


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”The Chinese economy and its conundrums”

October 16th, 2018

Presentation by Hubert Fromlet, affiliated professor at Linnaeus University (Linnéuniversitetet), Kalmar/Växjö at the Baltic Sea Region and China Day 2018, October 16

According to a large number of conclusions on the Chinese economy – in most cases coming from Western press and financial economists – the current state and also the future of the Chinese economy seem to be quite obvious. However, this view should be modified. My own experience – after having studied the Chinese economy during several decades – looks somewhat different. I would rather differentiate conclusions and forecasts on the Chinese economy between

¤ more or less obvious ones (little or no conundrum),
¤ more or less uncertain ones – but still logical and understandable (limited conundrum),
¤ more or less intransparent ones (total conundrum).

Applying the above-mentioned differentiation to current conditions, almost any evaluation of the Chinese economy becomes more complicated. At the same time, it becomes more obvious that the Chinese economy cannot be analyzed only occasionally. Instead, regular studies of the Chinese economy must be considered as inevitable.

Below, there is an attempt to use the suggested conundrum classifications in a practical and updated sense. This kind of analysis pattern could serve as a kind of analytical guideline for corporations and financial experts.

More or less obvious interpretations/conclusions

¤ Ongoing slowdown of the Chinese economy:
Statistics still do not show a visible weakening of the Chinese economy. GDP growth uses to vary with only around 0.1 percent from quarter to quarter since around three years ago. Official objectives and expectations are met. This phenomenon is very unusual, also for emerging economies. We are waiting impatiently for official GDP statistics for Q3 on October 19 – and the “allowed” deviation from (official) expectations and forecasts.

Also the Purchasing Managers Index (PMI) appears too stable; numbers above and below the borderline of 50 are interpreted and defined too strictly. The current official NBS number of the PMI at 50.8 is therefore not safely above the positive borderline since the different corporate answers to the PMI diffusion index do not measure the strength of possible changes on individual corporate levels – but only the categories “stronger/unchanged/weaker”.

My own interpretation of the currently (somewhat) decelerating growth path of the Chinese economy is preferably based on official statements, speeches and interesting headlines in the Chinese press. Some recent examples can be given here.

“China to adopt more proactive fiscal policy” (Xinhua Oct 8) – a signal for the need of some growth injection

“China cuts banks’ cash reserve requirement” (China Daily Oct 8) – the fourth cut in 2018 points at GDP worries

“Manufacturing growth slower in September…partly due to weakened export performance” (China Daily, Oct 1)

“No need to worry about China’s economy…” (China Daily, Oct 1) – why saying so if there are no concerns?

It should not be neglected that these quoted – and other – articles also include encouraging comments on the resilience and modernization of the manufacturing industry and the assumed ongoing progress of the service sector. But in my view, Prime Minister Li Keqiang by using the words “current pressure on the economy” should be taken more seriously than the more positive comments by less highly ranked officials.

On the other hand, it is indeed obvious that China is working hard on education and innovation systems, co-operation with foreign countries and companies included. This is badly needed for moving forward. The New Growth Theory (NGT) of this year’s Nobel Prize winner Paul Romer is at least partly applied in China.

“Chinese premier says foreign talent important to China’s innovation” (China Daily, October 1)a relatively safe conclusion about Chinese awareness of what is needed to compete globally.

More or less uncertain interpretations/conclusions

¤ The current state of economic reforms – we have too little knowledge about it:
In November 2013, the Chinese political leadership’s Third Plenum set up 60, quite concrete strategic objectives – to be met by 2020. Most of the objectives mean marketization and improved institutions – in line with the broad definition of institutions by Nobel Prize winner Douglass North; they would bring China forward substantially if implemented ambitiously.

However, more concrete discussions or presentations on already achieved reform progress are still absent or extremely rare. Transparency is by far too limited also in this specific respect (even if it has been improving on trend at least for the economy). This is a serious shortcoming and could damage China’s image in the whole world – and criticism may be at some point even become wrong or unfair once improvements really have taken place. Comments on the strategic reform policy issues are usually formulated like this:

The central bank “will optimize financing and credit structure so that the private sector will be better served” (Xinhua Sep 30) – confirmation that the private sector should receive better financial conditions, but how/when?

“Tasks set out for advancing law-based governance in China”(Xinhua, Oct 4).

¤ Correct indebtedness probably the largest conundrum – psychological links not to forget:
Here we come to parts of the Chinese economy where guiding conclusions seem to be impossible. But more or less totally lagging transparency also means that related risks from total China’s total indebtedness – may be around 275-300 percent of GDP and roughly twice the ratio of ten years ago – cannot be considered in an appropriate way. The risks can either be underestimated or overestimated. It may even happen also in this context that really happening improvements will not be recognized or appreciated because of the historical credibility deficits. This special – somewhat different – kind of risk is also linked to behavioral economics and behavioral finance.

¤ Institutional conditions five to ten years from now:
Quite a number of economic researchers (North, de Soto, Acemoglu, Blanchard, etc.) consider well-working institutions as the key – or at least a main key – for economic development. Sometimes, however, institutional improvements are conflicting with political positions or strategies. Altogether, there is a clear political strategy in China to improve institutions. Thus, institutional progress will be made – but how fast and how wide-ranging will these institutional reforms be at the end of the day?

The broad range of possible new opportunities
This article is mainly based on the risks of future development. Conundrums do exist – however, also as regards the possibilities – which good economic, educational and institutional policies plus technological achievements indeed may offer. Some more progress is certainly in the cards. However, there should be doubts about the verifications of the opportunities in their entirety. Nobody knows – whatever so-called China experts pretend to know. This conclusion makes it necessary to steadily remain updated.

Impossible interpretations/conclusions

Here we have special cases of conundrums that cannot be judged at all what concerns size, time and reactions. China offers a number of these conundrums, both when it comes to political, social and economic conditions.

¤ Final success or failure of intended economic reforms
There is no way to foresee the outcome of all economic reforms. There are many good plans, many of them in line with Western economic research. But economic and political goal conflicts exist which may mean obvious impediments to the future growth potential.

¤ Coming deflation or continuous strong inflation of the credit bubble?
One of the main economic questions of the future: Will China trigger the next global financial crisis because of its enormous debt problem and possible/probable contagion to other countries?

¤ Non-performing loans of the Chinese banks:
“Government support for major banks will remain strong in China to keep public confidence and systemic stability healthy” (China Daily, October 2) – however, why is government support actually needed?

There are few areas in the Chinese economy where official numbers and private estimates differ as much as it is the case of non-performing loans (NPLs). Nobody knows exactly the real NPL-numbers of the bad bank credits and the off-balance financing operations by the banks; and even less people are aware of the corresponding statistics for the so-called shadow banks which – surprisingly for many analysts – use to have direct links to the big banks. If we then, for example, add implicit and hidden bad loans coming from state-owned enterprises, the conundrum of the total amount of non-performing loans becomes totally puzzling. We do know about the problems of NPLs per se – but we have not got a clou about the real dimension of this conundrum; however, the official number for 2017 for NPLs of commercial banks appears by far too low and unrealistic (1.74 % of total loans) .

¤ Local debt – who and what is right?
I wrote already in 2013 an article on this topic which is found at (search yourself):

Still, my uncertainty about the size of local government debt has not declined. Chinese officials point at their version that current debt levels of local governments do not indicate major problems in the future – very much contrary to what financial markets and more critical experts believe with their much more pessimistic stance – including also, for example, comments directly from China (“China battles hidden local government debt”)

¤ Protectionism in the longer run:
Potential future protectionist threats cannot be analyzed well these days – and do not at all allow for any meaningful long-term prediction. Analysts are confronted with a total conundrum. At least in the short run, China may suffer from damages of the global supply chain.

¤ The sustainability of the current account surpluses and the opening of the capital balance:
China has been – and still is – a country with surpluses in the current account. This phenomenon gives (partly) a position of strength on global financial markets since China by definition does not need net cross-border capital inflows as long as these surpluses exist; instead, China is able to work with net exports of capital – either by short-term (portfolio) investments or long-term investments (FDI) abroad or by granting credits over the border.

However, the surpluses in the current account have been shrinking in recent years. Regarding possible further enlargement of foreign protectionist pressure, further concentration on loans for private consumption at home and more imports, and also more widening protectionism could finally make the current account more vulnerable – and, consequently have an impact on the future speed of opening the capital balance for free financial cross-border transactions of stocks, bonds and foreign currencies. All these theoretically possible developments are not foreseeable at all; we find here a most puzzling conundrum.

¤ Social conditions five to ten years from now:
Here we have another, completely secret box which cannot be opened any time soon. What we do know about this is the experience and results from research that there is an often existing relationship of the economy to social developments or the other way around. There is no doubt that the Chinese need more and better social security.

Final conclusions:

The discussions above should show that China’s short-term economic outlook – despite certain (statistical) problems – seems to be more predictable than the structural long-term perspectives. This can be concluded despite the current shortcomings in Chinese statistics, transparency and communication (which make also short-term forecasts more complicated than necessary). Altogether: China’s economy is characterized by many conundrums – but not all of them with completely unforeseeable outcome.

It will, for example, be interesting to see whether China will keep up its opaqueness also when it comes to the development of digitalization and artificial intelligence. China is still a country that can surprise – hopefully in an increasing number of cases in a positive sense.

But I also remember the words coined by an outstanding China expert in Hong Kong in the 1990s who repeatedly during each and every meeting there reminded me of his own “law” – simply asking the following question: What do we really know about China?

Today, economic transparency is better – but still insufficient. This is exactly the reason why this article deals with different alternatives of conundrums in the political and economic powerhouse of China – from quite limited conundrums to very large ones.

However: Despite all these conundrums, China will remain a most exciting country, for both analysis and business.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University
Editorial board


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The analysis of emerging markets is (partly) different

September 27th, 2018

Many analysts think that the important country group of emerging markets currently is on the edge of a new crisis. May be – or may be not. We do not know yet – but increasing risks are certainly visible. Six of them are – or may be – most challenging. They are:

– domestic and global political risks, increasing protectionism included,

– rising interest rates in the U.S.,

– weakening economic growth in the advanced countries,

– contagion among emerging countries,

– increasing global risk aversion from OECD countries in emerging countries,

– accelerating psychological exuberance without consistent fundamental basics.

We have to recognize that emerging markets still depend to a high degree on developments in OECD countries – despite the fact that emerging economies already today have a higher share of global production (in PPP terms) than all the advanced countries (but with markedly lower GDP per capita than the first group of countries).

Special characteristics of emerging markets

Thus, the analysis of emerging markets must include developments in OECD countries but also certain own characteristics of emerging countries . If we watch these special characteristics from a risk perspective, factors like political and social risks, institutions, maturity of financial markets, economic reforms and stability in general terms play a particularly big role – mostly considerably more than in a mature country; this is, of course, exactly why we have this distinction between mature (advanced) and emerging countries.

The current account balance – often neglected by analysts

Sometimes also two other developments or indicators can become decisive for the development of an emerging market – the current account balance and foreign debt. In mature countries, these two economic indicators are not focused very carefully (with the Greek crisis a couple of years ago as an outstanding exception).

Normally, there are no particular analytical emergencies in this specific respect. But they occur. However, even professional economists appear sometimes very unskilled when it comes to knowledge and interpretation of current account deficits. This happens mostly when emerging countries are derailing.

Current account deficits mean that a country has more imports than exports of goods, services and cross-border financial transfers like the interest rate and dividend payments.

Unfortunately, the consequences of a substantial and persistent current account deficit sometimes turn out to be very negative. Of course, emerging markets can run limited deficits in cross-border business – may be up to 4-5 percent of GDP or so without any distortion; however, the internationally “accepted” upper limit is not static and certainly interpreted more strictly when the current account deficits worsen further and/or economic or political problems increase. At the end of the day, the international financial and non-financial community may lose confidence in the country.

In reality, a current account deficit reflects a negative national savings performance. This means a debt in foreign currency vis-a-vis-other countries. This negative outcome has to be financed by inflows of foreign currencies. This can happen by definition in three ways:

– foreign direct investments (FDI; if foreigners still are interested when problems increase sharply),

– borrowing money abroad,

– selling stocks and bonds to foreign portfolio investors (if there is a capital market in the emerging country) – which also may become a major risk when foreigners because of increasing doubts suddenly sell these papers again.

The case of a big crisis

It also happens that current account deficits develop into an alarming crisis. This may happen when simultaneously a credit bubble is bursting. Another critical development may show up when there is a major minus in the current account and foreign debt is high at the same time.

Even worse: when in such a situation with a very weak current account balance and high foreign debt a substantial part of this foreign borrowing is short-term based. Such a situation can aggravate further when also the affected country’s currency more recently has been weakening largely – which recently happened in Turkey. In this specific case, foreign debt grows further.

Adding, for example, in the analysis of Turkey’s substantial deficits in the current account the high amounts of short-term foreign debt, it is quite easy to understand the uncomfortable future risks of the Turkish economy.

Still a lot of work to do

Above, some of the above-mentioned risks demonstrate very well that the analysis of emerging countries may differ quite a bit from the analysis of mature countries. This concerns particularly institutions, the balance of current account and the amount and also structure of foreign debt.

This kind of necessary expertise cannot be achieved by occasional studies of emerging countries. Instead, a lot of regular and deepening research and analysis is needed (otherwise, no applicable or reliable forecast on an emerging market economy can be launched).

Unfortunately, we are still far away from ideal preconditions for the analysis of emerging market countries. A lot of more homework has to be done also in our part of the world.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University
Editorial board


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