China Research

During our Swedish summer vacation, a number of events in China generated a lot of nervousness, both globally and at home. First, the Chinese stock market suffered from a major downturn after a previously gigantic upturn earlier this year, obviously spurred by officials. Second, the Chinese political leadership implemented some mini devaluations of the currency renminbi (RMB or sometimes called yuan) – and introduced also a somewhat more market-oriented daily fixing of the RMB.

Contrary to many players on financial markets, I do not consider the exchange rate policy steps as particularly surprising or exciting. As I indicated in previous papers and articles, more or less steady (slight) appreciations of the RMB during the past decade were at some point to lead to a more justified equilibrium – a situation that may have become more realistic now. The RMB may have been characterized even by a limited overvaluation in the past months when considering China’s currently shrinking exports (which can be referred to both a substantial number of less competitive Chinese export goods and insufficient global demand, i.e. partly structural factors) – despite the still existing surplus in the current account. I would not even blame China for its attempts to slightly weaken the RMB.

Exchange rate policy is part of economic policy – also occasionally in advanced OECD countries – more recently, for example, in Japan and Sweden. In Sweden, both the government and the Riksbank want the krona to be as weak as possible – though to some extent for different reasons. Like politicians in most other countries, Chinese political decisions-makers – i.e. the Standing Committee of the Politburo – do not care about foreign reactions on exchange rate policy either, as long as it favors the own objectives. By the way, this kind of nationalist attitude could also many times be found in the past in our traditional market-oriented economic systems, and it still can.

What worries me much more are the government interventions on the underdeveloped stock markets in Shanghai and Shenzen – and not the downturn as such, at least not for the time being. However, if Chinese stocks were to fall further for a considerable period of time – a couple of months or so – poor Chinese stock markets finally could have an impact on the real economy by the so-called wealth effect, both in China and abroad. Here we come to the research topic of behavioral finance – the research area Robert Shiller received the Nobel Prize for two years ago. Even if losses from stock ownership have not been realized, people may feel the potential losses as reality and, consequently reduce or shorten their consumption plans – even outside China, Sweden included. GDP would be negatively affected. Still, this negative wealth effect seems to be a bit away. But this risk has to be watched!

These were my first thoughts about the ongoing Chinese problems. The following second thoughts, however, may be more important. They reflect more fundamental concerns about the Chinese economy – concerns (without ranking) that are mostly neglected or forgotten in the current reports on the Chinese crisis – or whatever one may call today’s nervousness and uncertainty.

¤ Government interventions – are reformers losing momentum?
Chinese political leaders announced in November 2013 during the so-called Third Plenum of the Central Committee of the Communist Party that the market economy should play a decisive role in the new, future-oriented China. Most of the 60, mainly quite detailed economic, institutional and social objectives in the Third Plenum’s document stress the above-mentioned decisive role of the market economy. When regarding China’s recent political interventions on its two stock markets, we should ask ourselves if these actions were only temporary steps away from the quite ambitious ideas and reform plans of the Third Plenum – or a real defeat for the reformers with more far-reaching consequences in the longer run, as my colleague and latest co-author professor Doris Fischer from the University of Würzburg seriously considers (in Die Zeit, July 28).

¤ Real GDP growth in reality – how does it look like?
Officially mentioned concerns about exports, monetary easing, more infrastructure projects, etc., lead “automatically” to the question about current Chinese GDP growth in reality. For the second quarter, GDP growth was officially noted at 7 percent – as usual close to the official forecast and objective. But how does reality look like? In line with official statistics, worse or even much worse?

The past does not give us any good guidance. My own guess and experience tells me that current Chinese growth reality looks worse than official statistics express – and worse than it is defined by the political leadership as the “new normal”, i.e. around 7 percent instead of previous double-digit numbers. In this context, the Chinese have a problem. Even if the quality of Chinese GDP calculation should have improved more recently, how can we trust such conclusions once statistical improvements are announced or confirmed more officially? How can we trust more encouraging economic statistics once they show up?

The creation of confidence is deeply connected with more and better transparency – an institutional factor with still many shortcomings in China. My own concerns about China’s economic situation and outlook would certainly decrease if the Chinese succeeded to establish more reliable and sizeable improvements of transparency. This takes, however, a lot of time. Therefore, we will not know for sure for quite some time what really happens in the Chinese economy. Whatever all these rapidly emerging China experts way around the globe say and write about.

¤ The new growth model – revised, delayed or on track?
Official concerns about economic growth lead very directly to the question whether the broadly announced goals of visible progress in the value chain of industrial production and the intended transmission to more (sophisticated) service production will succeed or not. The gradual change to a new Chinese growth model should be considered as extremely important in the longer run for the future quality and rate of potential GDP growth (which would induce more focus on mid and high tech products for exports, more demand-oriented investments, more emphasis on private consumption and an increasing share of service production at the expense of industrial production). Altogether, it is still too early to fear upcoming problems with new growth model as a result of the current crisis. Business people and economists, however, should from now on look more carefully at the challenges for the new Chinese growth model and the reform-friendly politicians behind it.

¤ The banks and the whole financial sector – future damage from the current problems?
Here, we find a hidden problem almost no one talks about. If Chinese political leaders are on their way to pay less attention to a promising restructuring of the Chinese economy in order to roughly maintain short-term growth, the quality of the banks’ credit portfolios will further deteriorate. Already by now, the real volume of bad loans should be much larger than officially reported. But things could become worse – when considering the badly analyzed shadow banks as well. Altogether, credit risks are increasing. Unfortunately, transparency is more or less non-existent in this context.

One should also point at the fact – as previously commented on this page – that China still should be far away from making the RMB a convertible currency and from a complete opening of the current account balance (free cross-border capital transaction). It seems to be proven that previous optimism in this area was clearly premature – and too risky for global financial markets. China’s main focus in the forthcoming years should be decisive improvements of the lagging domestic financial market. It was certainly the right decision by the IMF to postpone China’s entry in the artificial currency unit SDR (plans which I described as a bad idea in my blog from June 3).

¤ Realistic and appropriate priorities in the new, 13^thFive-Year Plan for 2016-2020?
The answer to this question remains open at least until the Communist Party’s plenary session this October. The documents from this convergation will be important to analyze. Will China’s top leaders stick to the – mostly ambitious and promising – plans from the Third Plenum in 2013? Or will there be less market-oriented deviations ?

However: Having dealt daily with the Chinese economy for more than 20 years, I have a strong feeling that it would be wrong to neglect many positive economic developments in China during the past decades – and China’s also (sometimes) existing flexibility in economic policy. But we also know that China’s future way forward would have been easier at this stage if institutional progress – particularly regarding corruption, transparency and statistics – had received more attention and had been improved more ambitiously during the past ten to twenty years.

The price for shortcomings in these – and other – neglected areas gets higher and higher. For example, I would like to know more about the real volume of local debt. The last official number is from estimates by the National Audit Office (NAO) in 2013. This tells me a lot – but not really what I am really looking for. China could benefit so much from better transparency. At least in the longer run.

 

Hubert Fromlet
Senior Professor of International Economics, Linnaeus University
Editorial board

 

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