Spending time

By Geoff Dyer 2008-10-22

For the past five years, China has enjoyed what can only be called turbo-charged growth. In each year, the economy not only expanded by more than 10 per cent but in each year the growth rate also accelerated.
Such a rapid pace of expansion could not continue forever and this period is now clearly coming to an end. But what sort of slowdown China experiences during the next few years remains unclear.
The government is hoping for a gradual decline in growth to more sustainable levels which will take some of the steam out of property markets, but without damaging employment too much. The performance of the economy in the first half of the year, when it expanded by 10.4 per cent, appeared to indicate this was happening. “The slowdown has only been gradual and will likely remain so for the rest of the year,” says Qu Hongbin, economist at HSBC in Hong Kong.

However, there is an increasing amount of evidence that China might suffer a much sharper slowdown that would include a sharp drop in property prices, a decline in exports and problems in the banking system. Stephen Green, economist at Standard Chartered Bank in Shanghai, has one of the more pessimistic outlooks for China, predicting 7.9 per cent growth next year and 7.1 per cent the year after.
While most other countries would be happy for such a forecast, slower growth would have big implications for many of the UK groups that have invested heavily in China, such as HSBC and Standard Chartered and retailers Tesco and Marks & Spencer – which opened its first store in China earlier this month.
The sector of the economy that will inevitably suffer is exports, which have been one of the principal drivers of economic growth in recent years. To the surprise of many economists, China's exports have grown more than 20 per cent this year, despite the slowdown in the US. In part, this is because exporters have managed to find new markets for their products in booming emerging economies, such as Brazil and Russia, and in the Middle East.
But the problem for China's exporters is that two of their other biggest markets – the European Union and Japan – are also now suffering real economic problems, which will make it much harder for companies in China to keep expanding exports.
Indeed, there are already signs of real distress from parts of the export sector. According to the National Development and Reform Commission, China's main economic planning body, 67,000 small companies have closed down so far this year, most of which are likely to be in the export sector.
The economy could cope with weaker exports. However, it will be much more vulnerable if there is also a big drop in investment, which has been one of the other main drivers of growth.
As a result, close attention is now being paid to the property sector, which is one of the most important components of overall investment, but which is looking extremely exposed. Data on house prices in China can be difficult to assess: while the government's main price index for 70 cities shows that prices fell modestly last month, the anecdotal information from a host of different cities suggests there have been big drops in prices.
There is more conclusive data of an impending slump in the market. Last year, the number of properties sold increased 26 per cent, but in the first half of this year it fell by 11 per cent. In August, the amount of floor space under construction fell – an indicator that was backed up by weak figures for steel and cement production. “The only real way out is for prices to fall sharply or for the government to bail out developers,” says Shen Minggao, a former Citigroup economist now working at Caijing magazine.
The government has been actively trying to cool the property market, introducing a string of measures to limit credit to property developers and to make it harder to obtain a mortgage. However, the risk is that the slowdown in the housing market will go too far.
A property crash could cause a cascade of unwanted effects: if too many property developers went bankrupt, it would increase unemployment; local governments rely on sales of land to finance a lot of their spending; and it would cause considerable pain to the banking sector, given that about 30 per cent of all loans go to either developers or mortgages. “There is bound to be a big increase in non-performing loans if property prices fall sharply,” says one researcher at a government think-tank in Beijing.
With exports and investment both under large clouds in the next couple of years, the performance of Chinese consumers has become much more important. The headline news about consumption has been extremely positive: in the past two months, retail sales have risen 23 per cent, which is close to the highest level in the past nine years. The buoyant figures have encouraged some economists to predict that the country's consumers could prevent the economy from slowing too sharply during the next year.
Yet beneath the surface, a number of questions have been raised about just how robust the retail sales really are. Several important industries have reported a very different situation – car sales, for example, have begun to decline during the past month and air travel slumped over the summer. Income figures also present a much less optimistic outlook, with the rate of growth in urban incomes dropping 50 per cent in the first six months of the year. And if the housing market slumps, that will inevitably spill over into consumption as fewer people buy washing machines and sofas for new homes.

The good news is that the Chinese government has more room for manoeuvre than most others responding to a slowing economy. With consumer price inflation dropping in recent months, it has some space to cut interest rates, although inflation at the factory level remains high.
On the fiscal front, China could reap the benefit of the conservative budget policy it has been running in recent years. The authorities have plenty of scope to accelerate spending on railways, roads and metros to boost overall investment.
“If the economy slows much more sharply than we expect, we have no doubt that Beijing has the financial capacity and the political will to step in quickly with fiscal and administrative measures designed to boost growth,” says Andy Rothman, economist at the brokerage and investment house CLSA in Shanghai.
Yet if property woes cause a collapse in private investment, there is only so much the government can do to make up the gap. Given the big questions now hanging over the Chinese economy, many economists believe the government needs to accelerate a series of reforms it has already outlined that would shift the balance of the economy away from production and towards consumers.
For a number of years, China's leaders have understood that they cannot rely forever on large yearly increases in exports and rapid rates of domestic investment. If high rates of growth are to be sustained in the long-term, they concluded, then consumption has to play a larger role in the economy. In particular, to get Chinese to save less and consume more, the authorities need to expand a social security network that few people currently have confidence in. The prospect of a global recession and a local property crash have brought home the need to implement this agenda more forcefully.