Baltic Business Research

1. My previous forecast and some brief evaluation
In my report on China from February 10, 2010, I wrote that “China will achieve quite a good  GDP    growth in 2010 in the range of 9-9 ½ percent, despite more tightening of credit conditions and uncertain global conditions. Two interest rate hikes by totally 0.54 percentage points are implemented in this forecast. This is not a very scary tightening…There is a non-negligible risk that inflation will exceed the unofficial comfort ceiling of 4 percent…More skepticism should be applied to 2011… A somewhat lower rate for Chinese GDP growth seems to be appropriate in 2011, around 8 ½ – 9 ¼ percent…”

2. Every reason to be humble – many economists comment too “westernized” on China
Soon, we will get the number for Chinese GDP growth in 2010, probably a notch higher than my prediction a year ago (rather around 10 percent). Interest rates were raised by 0,50 percentage points in 2010, and inflation had climbed to 5.1 percent in November (yoy). Totally, my view on the Chinese development in 2010 was quite right. However, after having dealt with the Chinese economy during more than two decades, I  think there is every reason to treat comments and forecast on China both cautiously and with necessary humbleness. The Chinese economy is so huge and intransparent – which makes it impossible to be comfortably sure about policy reactions and mathematical reaction functions!
For this reason, market comments such as “the recent Chinese credit restrictions were implemented in time” cannot be more than unsophisticated guesses. Many comments on China by financial analysts in our part of the world have become too “westernized”. China is special – and needs therefore to be analyzed in a very unique way.

3. Somewhat dampened GDP growth still to be expected
My GDP forecast for 2011 – looking at range of 8 ½ and 9 ¼% – still seems to be valid (applying the official statistics we are provided with; the reality may look somewhat different or hotter because of statistical shortcomings). I do not see a major Chinese slowdown already during the current year – despite a number of considerable risks in the longer run. It cannot be ruled out that Chinese GDP growth in 2010 has been higher in reality than shown in governmental GDP statistics when recent  warnings by high officials, restrictions on new credits and car registrations, etc., are considered more severely. It also seems to be realistic that inflation is about to develop as a much bigger problem than previously assumed by the authorities. There seems to be an unofficial inflation target around 3-4 percent, both for short-term social and income distribution reasons).  Anyway, further interest rate hikes and credit restrictions should be on the cards, at least in the first half of 2011. I expect official benchmarking interest rate hikes in the range of 0.50-0.75 percentage points during the forthcoming 2-3 quarters.

4.  Continuous upward pressure on the currency
Higher interest rates should – ceteris paribus – lead to  further speculative appreciation pressure on the Chinese currency (which sets a limit to the willingness of strengthening the currency).  According to my China panel from October last year, the China experts foresaw the currency RMB during 2011 to

#  appreciate by 1-5 percent  (63 percent of the panelists)
#  appreciate by more than 5 percent  (32 percent of the panelists)
#  remain stable  (5 percent of the panelists).

I can imagine that a stronger currency may be used a little bit more to combat inflation than in the past year. However, such a policy will not have a major impact on price increases, since the share of imported goods in the consumer price index is too limited. Food prices play a much bigger role in this context. A total appreciation of the yuan against the U.S.dollar  between 4 and 6 percent seems to be the most probable scenario during this year.

5. Difficult to manage overheated economy in an inflexible political system
Western economists tend to overestimate the ability of the central government to achieve an effective fine-tuning of the economy. We know, for example, that prime minister Wen Jibao has been warning for the negative consequences of an overheated economy for several years – so far with unsatisfactory results. He and his government certainly would have liked to see more concrete results in the attempt to tame the economy. It’s still difficult to manage an overheated economy in an inflexible political system – particularly on the local level. Many provincial and local leaders stick to their ambitious expansion and growth plans, especially in the construction sector – despite central objections. This development has been sharply contributing to the continuous upturn of prices of new commercial and residential construction, not only in the hottest (tier one) cities. There is still a clear lack of local co-operation with central forces.

6. China’s support of suffering EMU-member countries not only unselfish
In principle, it has to be regarded as positive that China supports Spain and other suffering EMU countries. Such a step reflects at least certain Chinese confidence in the eurosystem. However, such a kind of emergency support  is not only unselfish. China has already started up a process of diversifying its currency reserve from the U.S.dollar to the euro which, of course, would be hindered by a steadily and/or strongly weakening euro. According to my own information, there is also a widely spread feeling among Chinese financial decision-makers that the dollar at some point will go back to its downward trend. Furthermore, China definitely does not want to see a further weakening of GDP growth in Euroland which is such an important market for Chinese sales.