China’s landing - soft not hard
A staff member counts money at a branch of the Bank of China in Lianyungang, Jiangsu Province. (Getty Images)
October 5th, 2011
10:30 AM ET

China’s landing - soft not hard

Editor's Note: Stephen S. Roach is a member of the faculty at Yale University, is Non-Executive Chairman of Morgan Stanley Asia and the author of The Next AsiaFor more, visit Project Syndicate or follow it on Facebook and Twitter.

By Stephen S. Roach, Project Syndicate

China’s economy is slowing. This is no surprise for an export-led economy dependent on faltering global demand. But China’s looming slowdown is likely to be both manageable and welcome. Fears of a hard landing are overblown.

To be sure, the economic data have softened. Purchasing managers’ indices are now threatening the “50” threshold, which has long been associated with the break-even point between expansion and contraction. Similar downtrends are evident in a broad array of leading indicators, ranging from consumer expectations, money supply, and the stock market, to steel production, industrial product sales, and newly started construction.

But this is not 2008. Back then, global commerce was collapsing, presaging a 10.7% drop in the volume of world trade in 2009 – the sharpest annual contraction since the 1930s. In response, China’s export performance swung from 26% annual growth in July 2008 to a 27% contraction by February 2009. Sequential GDP growth slowed to a low single-digit pace – a virtual standstill by Chinese standards. And more than 20 million migrant workers reportedly lost their jobs in export-led Guangdong province. By late 2008, China was in the throes of the functional equivalent of a full-blown recession.

Thanks to a massive fiscal stimulus, China veered away from the abyss in early 2009. But it paid a price for this bank-funded investment boom. Local governments’ indebtedness soared, and fixed investment surged toward an unprecedented 50% of GDP. Fears surfaced of another banking crisis, the imminent collapse of a monstrous property bubble, and runaway inflation. Add a wrenching European crisis to the equation, and a replay of 2008 no longer seemed far-fetched.

Read: Bleed the foreigner.

While there is a kernel of truth to each of these China-specific concerns, they do not by themselves imply a hard landing. Nonperforming loans will undoubtedly increase in response to the banking sector’s exposure to some $1.7 trillion of local-government debt, much of which was incurred during the stimulus of 2008-2009. But the feared deterioration in loan quality is exaggerated.

The reason: With rural-urban migration projected to exceed 310 million people over the next 20 years, there is reason to believe that much of the apparent overhang of housing supply will be steadily absorbed. Like Shanghai Pudong in the late 1990’s, today’s Chinese “ghost cities” are likely to be teaming urban centers in the not-so-distant future. Meanwhile, deposit-rich Chinese banks have ample liquidity to absorb potential losses; the system-wide loan-to-deposit ratio is only about 65% – well below earlier pre-crisis levels that were typically closer to 120%, according to a recent analysis by the Xerion team of Perella Weinberg Partners.

Nor is the Chinese property market about to implode. Yes, a building boom and speculative excesses have occurred. But a year and a half ago, the government moved aggressively to dampen multiple property purchases – raising down payments to 50% for second homes and to 100% for third homes. While that halted much speculative activity, house prices have remained at elevated levels – underscoring lingering affordability issues for China’s emerging middle class.

Notwithstanding that problem, major imbalances in Chinese property markets should prove to be the exception over the next two decades.  While there could be supply-demand mismatches in any given year, with an average of roughly 15 million citizens a year slated to move from the countryside to newly urbanized areas, demand should rise to meet supply.  Meanwhile, there are encouraging signs that property inflation is now cooling: For 46 of 70 major Chinese cities, property prices either declined or stayed flat in August 2011 compared with 31 cities that reported similar conditions in July.

Inflation is always a serious risk in China – especially with headline increases in the country’s Consumer Price Index surging through the 6% threshold this summer. The government has responded forcefully on four fronts.

First, food inflation, which accounts for about half the recent run-up in overall prices, has been addressed by administrative measures aimed at cutting fertilizer costs and removing bottlenecks to increased supplies of pork, cooking oil, and vegetables. Second, in an effort to curtail excess bank lending, reserve ratios were increased nine times in the past 11 months. Third, the rate of currency appreciation has edged up. Finally – and perhaps most importantly – the People’s Bank of China has raised its benchmark policy rate five times since October 2010. At 6.5%, the one-year lending rate is now 0.3% above August’s headline inflation rate.

If food inflation recedes further, and the headline inflation rate starts to converge on the 3% core (non-food) rate, the result will be the equivalent of "passive monetary tightening" in real (inflation-adjusted) terms – precisely what the inflation-prone Chinese economy needs.

Read: The microfinance catalyst.

All of this underscores a potential silver lining. An increasingly unbalanced Chinese economy cannot afford persistent 10% GDP growth. Provided that there is no recurrence of the severe external demand shock of 2008 – a likely outcome unless Europe implodes – there is good reason to hope for a soft landing to around 8% GDP growth. A downshift to this more sustainable pace would provide welcome relief for an economy long plagued by excess resource consumption, labor-market bottlenecks, excess liquidity, a large buildup of foreign-exchange reserves, and mounting inflationary pressures.

For China, there is a deeper meaning to recent global developments.  A second major warning shot in three years has been fired at this export-led economy.  First, the United States, and now Europe – China's two largest export markets are in serious trouble and can no longer be counted on as reliable, sustainable sources of external demand. As a result, there are now major questions about the sustenance of China's long powerful export-led growth model.

Accordingly, China has no choice but to move quickly to implement the pro-consumption initiatives of its recently enacted 12th Five-Year Plan. Strategic transition is what modern China is all about. That’s what happened 30 years ago, when economic reform began.  And it needs to happen again today.  For China, a soft landing will provide a window of opportunity to press ahead with the formidable task of increasingly urgent economic rebalancing.

The views expressed in this article are solely those of Stephen S. Roach. Copyright: Project Syndicate, 2011.

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Topics: China • Economy

soundoff (8 Responses)
  1. huyu

    The world should know that other than praises for our fellow men in other countries, we Chinese have nothing to say about other inhabitants of our shared planet. We would always find faults with ourselves for only then we can strive to improve, even if it proves to be impossible. Certainly sticking our nose into other people's knickers is not one of our habits.

    But, commerce, we are most enthusiastic for.

    These are nice knickers indeed. I have in possession 1,000 different styles here to satisfy your most basic and the most exciting carnal needs. From the most Economy models to the most Zakaria. Drop a call, and we can do business, just like Lady Baroness T. said.

    We have so many our own problems, if you know them yourself, your mind probably will explode. Because of our retardedly developed venting machines and lack of such propaganda splendors like the CNN, or Fox, or the New York Times, we usually get off by breaking your nose; whenever, for some reason my spit flies off onto your fragranced face. Or sometimes chopping a few heads off, especially when we have these water fights break out. I sometimes wonder how the Messers like Mr. Hu, Wen, Ho, and Whi can ever sleep; the jobs have to be a life expectancy killer bordering on self-assisted suicide, and so little pay, and not even a mistress or two.

    If you see any Young & Restless (FengQing) like our proverbial Mr. fish, just please please please, ignore him. How does he know that no one ever falls off the train in China while speeding at 200 miles per hour, and how would he know maybe some people prefer to sit on the roof of the train for a more splendid view, and indeed superior air to breathe in the scorching sun at a more leisurely pace.

    And indeed, on his miserly 5,000$ annual income, and a clear lack of in-the-know on our planetary affairs, how would he contribute to such galactical human endeavors as whether white cats are superior to the black cats, or the black ones to the white ones, or maybe even both. It is indeed much preferable to leave such high-intellectual exercises to our Mr. fish'es IQ beating western oratoriatators and Indian Brahmins.

    His patriotism is admirable, but it is not what most of us think in China. There is nothing in the world that we want other than to get the next bottle of Maotai (read expensive), my wife's next Gucci bag (fake actually), any my kids next lessons (rote learned anyways), the next car, the next house, or the next mistress (shhiii...).

    To claim that China will model this or that really is just a little bit over the top; our best known models are the ones most slimly clad, smiling splendidly, who whispers with that most tender, vibrating voice, while posing in the most fantastical ways at the Beijing Motor show. You see, that really got my plum in my mouth wriggling.

    For such mundane matters, we prefer to delegate to Uncle Sam. Nice Uncle indeed, who spends the money and body bags to trouble shoot for all us. It is a good bargain, we are already getting used to it.

    October 5, 2011 at 11:25 am |
  2. j. von hettlingen

    "The United States, and now Europe – China's two largest export markets are in serious trouble and can no longer be counted on as reliable, sustainable sources of external demand. As a result, there are now major questions about the sustenance of China's long powerful export-led growth model."
    True, no country can prosper indefinitely, but China's performance is still strong. It's growth depends very much on the well-being of the West. It's interdependence! Our excessive spending led us into this abyss. Now China can help us out by consuming more. Let's hope we would benefit from their shopping spree.

    October 5, 2011 at 11:55 am |
    • USA

      "Now China can help us out by consuming more. Let's hope we would benefit from their shopping spree."
      I disagree. China is no help to us if we do not correct our own mistake. The Chinese made a full u turn to become who they are today. What we need is a Chinese style " economic reform ".

      October 5, 2011 at 3:15 pm |
      • vokoyo










        October 25, 2011 at 9:09 am |
  3. blessedgeek

    Is China dissociated with free democracy? Is there future for free democracy in China?

    The effects of free democracy in China within the next 10 years will be catastrophic to China more than what Greece and Italy is experiencing. The effects of free democracy would would reversal to oligarchic warlordism.

    It took Taiwan 30 years from false steps of democracy to full-fledged democracy+prosperity. It took South Korea about the same time.

    China has introduced local elections at municipal levels. But see what has happened. When the central govt turned their head away, the provincial leaders decided to install their own relatives and friends into the provincial communist party and then decided to use provincial law enforcement to harass independent candidates. Whereas, municipal politics at locations closer to the eyes of the central govt (like Beijing and Shanghai do not face this issue).

    Therefore, with free democracy in China now, that democracy will crumble in now time into oligarchy and false Capitalism will run amok and will become much much worse than the false Capitalism we have in the US.

    I am sure China wants to have free democracy. So in the mean time, we have to be cautious and be watchful of the path that China is taking. They may revert to more authoritarianism which would be difficult. But I predict they will end up with a socialist-democratic system like France or Germany.

    October 5, 2011 at 9:46 pm |
  4. Golden Networking

    If you want to learn the latest about doing business with China, there is a conference, China Leaders Forum 2011, "How American Companies can Plug Into The Chinese Rocket-Propelled Economy", October 7 in New York, that will examine the challenges facing American companies that want to grow and expand their business in China and the opportunities to find Chinese investment partners that can provide a much-needed capital injection while opening the Chinese market. More info: http://www.ChinaLeadersForum com

    October 5, 2011 at 10:41 pm |
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