Baltic Countries

”The Chinese economy and its conundrums”

Tuesday, 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) http://www.chinadaily.com.cn/a/201802/09/WS5a7d8c78a3106e7dcc13bdca.html .

¤ Local debt – who and what is right?
I wrote already in 2013 an article on this topic which is found at (search yourself): https://helda.helsinki.fi/bof/bitstream/handle/123456789/12599/172270.pdf?sequence=1

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”) https://www.caixinglobal.com/2018-03-11/china-battles-hidden-local-government-debt-101219793.html.

¤ 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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Poland – why it succeeded so far

Wednesday, January 13th, 2016

Newspapers and politicians all over the world currently show a high degree of disappointment about Poland’s political development after last year’s general elections. Fears of markedly reduced democracy are expressed quite loudly. Economists, however, are more silent. This fact may confirm once more that foreign analysts at financial institutions and elsewhere usually are not well informed about economies outside the traditional OECD area (though Poland nowadays is an OECD country). This is – by the way – also true of China for which herd analysis usually dominates even outside the country, particularly among most financial players.

In my view, recent developments in Poland should not be underestimated. Poland’s strong emerging role during the transition to a working market economy was indeed impressive. Poland was even the first country among the former planned economies in (South) Eastern Europe that reached pre-1989 GDP levels. I have seen Poland’s impressive development many times with my own eyes since its opening-up in 1990.

The secret behind Poland’s success story until recently was without doubt that Poland – more or less – never moved backward in its reform policy. Sometimes Poland moved somewhat more to left of the road, sometimes a little more to the right – and the pace of reforms was during certain periods quite slow and during other periods more accelerated.

But the direction was always forward – and never really backward! This is probably the most important explanation of Poland’s political and economic recovery in the past 25 years. My own research has also confirmed in a number of studies that reliable and steady – sometimes quite slow – moves forward usually mean more to sustained economic growth than a mixture of fast structural improvements and following setbacks.

So, why should Poland want to jeopardize its achieved, good international credibility position? Foreign companies have invested a lot in Poland and, thus, contributed strongly to Poland’s fairly good international competitiveness. In other words: it should not be ruled out that reality and memory can take this quite large European country back to frameworks that are in line with nowadays valid European standards. However, good psychological feeling should be applied – particularly by Poland’s partners in the EU and in NATO. Such a position seems to be more promising than threats – if I understand Polish mentality correctly.

Anyway, the analysis of Poland’s political and economic development should be intensified in many international institutes and commercial organizations. We should keep in mind that Poland is an important European country – though often underestimated.

 

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

 

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The Baltics in Search for Exports

Wednesday, June 3rd, 2015

In 2014, Estonia grew by 2.1%, Latvia by 2.4%, and Lithuania by 2.9%. Flash estimates for Q1 2015 report GDP growth dipping to 1.2% YoY in Estonia and Lithuania (contraction of 0.3% and 0.6% QoQ), and 2.0% in Latvia (still up 0.4% QoQ). Investment activity has been quite weak for a couple of years whereas consumption growth has remained by and large robust. Thus, the key reason for the dip in growth seems to be external, i.e.: (i) collapse in Russian demand, and (ii) subpar EU growth.

If subpar EU growth has tamed the upside for the Baltics (overall it still holds good growth prospects as the EU demand is still rising), Russian contraction and especially the rouble depreciation have an outright negative hit. The reason for Russia’s contraction is its chronic structural weaknesses (excessive dependence on oil, poor rule of law, weakness of market institutions) – reinforced by sanctions (impaired access to finance and technologies due to the sanctions from the West, but also Russia’s own imposed embargo on food imports) due to the Russia-Ukraine conflict.

Flash estimate for Q1 2015 reports Russian GDP to have shrunk by 1.9% YoY. Real household incomes are down about 10% YoY as are retail sales; investment activity seems to have fallen through the floor. It could have been worse… with oil prices gradually picking up, the rouble has stabilized at somewhat stronger levels than expected, which means that inflation, though still at about 16%, seems to have peaked and is likely to start retreating. Industrial output has reported small positive numbers. Still, Russia is set to shrink further this year and recession is likely to end only in 2016. Moreover, when recession will end, recovery will be bleak low single digits as its old oil-driven growth model has run out of steam and there is nothing broad and strong enough to substitute for it. So, there is not much hope for strong demand growth from Russia over the longer term either, even when ignoring the lagging rule of law, investor protection and geopolitical risks.

How does this Russia trouble affect the Baltic economies? It has cut sharply into the Baltic exports – in Q1 2015, goods exports to Russia fell by 29% for Latvia, 34% for Lithuania (-60% for Lithuanian origin goods) and 49% for Estonia from one year ago. More difficult to measure, but confidence must also have suffered, reducing investment activity. Yet, the overall impact is not that devastating at all. Despite the massive drop of exports to Russia, total exports have grown a tad for Latvia (up 0.4% YoY), and only marginally inched down for Estonia (-0.4%) and Lithuania (-3.8%; -4% for Lithuanian origin goods).  Thus, the good news is that the massive fall in the exports to Russia have been compensated with expansion in other (mainly EU) markets. So far we see only limited and contained impact – within certain sectors or companies – on corporate profitability and liquidity.

In short, the Baltics are coping quite well with this. One of the reasons is that it is not the first time the Baltics see something like that; during the 1998 Russian crisis, for example, dependence on trade with Russia was much larger than it was before the current watershed, so companies have been diversifying their markets for a long time. As to the sanctions – Russia has had a habit of introducing one off sanctions against specific goods already before and also quite regularly (e.g. there was a ban specifically on Lithuanian milk products in 2013). Companies know how to react in such instances. Yes, this is costly, but companies have seen it before and know what to do.

We expect the Baltic goods exports to Russia to fall by 30%-50% in 2015, and trade links with Russia to weaken substantially. Russia’s share in goods exports has been shrinking, e.g. for Latvia, from 9.4% in Q1 2013 to 6.8% in Q1 2015. To compensate for the shortfall in Russia, there has been a spectacular growth to many so far for quite exotic markets for the Baltic exporters such as Middle East, China or Japan. But the major volume growth has been already established to the core partners of the EU. The share of destination EU has risen, e.g. for Latvia from 70.9% in Q1 2013 to 75.4% in Q1 2015, and it is likely to continue going forward. If political alliances for the Baltics have clearly been with Europe, fast and lucrative export growth to Russia and its peripheral trade partners at times may have put politicians in a situation to weigh among political and economic alliances… now political and economic alliances are likely to become closer aligned, which will add to stability – and this is good.

We see the dip in early 2015 as temporary since a gradual pick up in EU growth (supported by ECB quantitative easing stimulus) must lift European demand and thus the Baltic exports and consumer spending. Overall, we expect the Baltics to grow by about 2% in 2015 and 3% in 2016. Slower than before, but not that bad either.

Annual_Growth_of_Goods_Exports_3M_Average

 

 

 

 

 

 

Mārtiņš Kazāks
Swedbank Deputy Group Chief Economist and Chief Economist for Swedbank in Latvia

 

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