100 articles on Economic- (5) Central to just about everything , Chinese economy and its future

Precaution:  This is the original script for the article bearing same title published on Capital Magazine, an annual magazine published by Imperial College Finance Society. The material inside is not updated and there would be many grammar error presented.

China hope to rebrand itself by hosting the World Expo in Shanghai this year. It may success, with spending already the largest in expo history, shanghai expo is on its tract to attract 70 millions visitors, another world record. But it will come with a heavy cost, as the total building cost and running cost of the event, together with the supplement infrastructure upgrading cost, had reached a staggering figure of £45bn. [1][2] However, the spending will be deemed necessary, as the year 2009 had been a hard year for major economy in the world, china was not excluded with a fall of 16% of total export value. [3] China can still enjoyed a miraculous GDP growth of 8.7% thanks to government stimulus package of 4 billion renminbi which mainly involve investment on infrastructures, such as the shanghai one. 

Light display showing greeting to brother Hu, the current president of PRC

Source: 2010.people.com.cn

            Whats interesting is not how they spent it, but how they financed it. As most of china government bonds circulate in local market, the only way government can acquire fund without squeezing private investments is expanding the credit provided by the banks. Which can be done easily as the central bank is under control by state council of PRC, while most commercial banks are state owned. Hence, the total amount of renminbi loans increased by 9.59 trillion in 2009[4], more if the central bank haven’t tightening the control of credit at second half of the year. As china economy doom is largely due to shrink in export but not shrink in local consumption demand, an expanding credit base plus massive government spending inevitably cause rise in inflation,[5] especially in the housing market and stock market.

Hence, many were in disbelief when National Bureau of statistics of China announced that the average house price rise for 70 major cities in 2009 was just 1.5 %. While the month to month average index of January 2010 shows a more realistic figure of 9.5%, [6] closer examination reveals a staggering rise of 20% in the city of Shenzhen alone, a city supposedly taking the most severe impacts of export shrink. The shanghai stock exchange index record a rise of 76.1%[7] throughout the year 2009 too, second highest in major economy worldwide. When the major western economies still suffer from the aftermath of housing market crash, tackling the housing market boom has become the main problem for the government and People’s bank of China (the central bank) .There are three tools available, namely renminbi exchange rate, control of credit, and interest rate, but neither can limit the overflow of liquidity into housing market, without hurting other side of the economy.

When Huang Guang Yu, the founder and controlling shareholder of Gome, a vast retail electronics chain was arrested and put into trial, few noticed one of his acknowledged crime, illegally converting about HK$ 800m from RMB. As we all known, RMB is still not freely exchangeable in the market as there is need to protect the export driven industry from currency appreciation. An increase of 486 billion US dollar foreign exchange reserve[8] compare with a trade balance of 196.1 billion US dollar[9] in year 2009 surely indicated that the RMB is under valuated. What putting the People’s bank on hold is the recently publicized pressure test report conclude that, an appreciation of 3% of the currency will reduce the profit of textile, electrical and electronic, light and medium industry by half. [10] Hence, given the world trading environment remaining weak, the People’s bank of china is unlikely to let the RMB appreciate, even under tremendous pressure from its largest trading partner, the America.

Raising interest rate seemed to be more viable choice for the People’s bank of china now, except that it might ruin the effort of relevant authority in directing china people’s money from saving into consumption. Besides, as small increase of interest rate wouldn’t stop people dumping money into market that saw house price rise by 20% per year, a large interest rate hike will put more pressure on RMB exchange rate. Therefore the interest rate will only be raised moderately in the foreseeable future to curb the inflation.

This leaves the People’s bank of China, only one choice, control the total amount of credit. Unlike the western counterparts, china central bank can directly setting the amount of credit, instead of control it indirectly by regulating the money base. The China banking regulator commission will ‘suggest’ the total amount of credit that can be increase by the commercial banks, when the bank exceed the limit, the particular bank will be ‘punish’ by raising its deposit reserve ratio. The ‘target’ for total increment of credit this year is set to be 7.5 trillion RMB. [11] Since massive government infrastructure projects are still on going, the majority of the increment will likely flow to local governments or state-owned company.[12]  This will force the SMEs turn into private loans which bear interest rate as high as 100%. [13] Thus, view from the outside will see China still enjoying growth of 10% of GDP, but closer examination will reveal a worsening environment for SMEs that hire majority of the workforces.

The State Council of china does try to curb the housing market bubble directly by implementing policy such as increasing down payment ratio requirement.[14] Past experiences suggest that this will hardly work, given local government strong dependant on housing market growth as source of GDP growth and financial income now. Besides, since the taxation reform in year 1994 that left local government to mind their own finance, there is pressure between local governments in competing for economic growth in the fastest way. Beijing had its Olympic game in 2008 which bring new subway lines, Shanghai enjoying its expo this year with massive infrastructure upgrade, other cities will demand such scale of investment, through one or other form.

            The growth of renminbi loans is about 3.37 trillion for the first four month of 2010, bringing an increment of M2 by 4.63 trillion.[15] The central government might have less control on how much the local government spending, but the state council still has unchallenged power in controlling total amount of credit. Given the political pressure build up by rising house price, the China Banking regulator commission is very likely going to force the commercial bank decrease the new amount of lending later half of the year. This measure combining with other effort like maintaining exchange rate and keeping interest rate low, will help China economy grows healthier in year 2010.

As conclusion, given that china service sector GDP ratio still low (40.5%) and the household savings rate still high (30%) , given that the effect of four trillion RMB rescue package still not yet fully actualize, given that the local government still thirsty in chasing growth, china economy will continue to grow in fast pace for upcoming year, which will only stopped time by time by the central government who afraid of overheating.

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[1] The Guardian, http://www.guardian.co.uk/world/2010/apr/21/shanghai-2010-expo-party

[2] Sino newspaper, http://www.sino-manager.com/2010511_14462.html

[3] China custom, http://www.customs.gov.cn/

[4] People’s bank of China,http://www.pbc.gov.cn/diaochatongji/tongjishuju/gofile.asp?file=2009S03.htm

[5] People Daily, http://english.peopledaily.com.cn/90001/90778/90862/6989627.html

[6] National Bureau of statistics of China, http://www.stats.gov.cn/tjsj/jdsj/t20100211_402621195.htm

[7] Economic and financial indicator, The Economist January 2^nd to 8^th 2010 issue.

[8] People’s bank of China, http://www.pbc.gov.cn/diaochatongji/tongjishuju/gofile.asp?file=2009S09.htm

[9] US-China Business council, http://www.uschina.org/statistics/tradetable.html

[10] Economic reference newspaper, http://finance.jrj.com.cn/2010/04/0200007225556.shtml

[11] Government working report by Premier Wen, http://www.gov.cn/2010lh/content_1555767.htm

[12] China SMEs survival report, http://qkzz.net/article/99aca02b-50ec-4740-b006-b27aa82db29a.htm

[13] http://bank.hexun.com/2010-03-01/122802396.html

[14] State council 10th notice (2010), http://www.gov.cn/zwgk/2010-04/17/content_1584927.htm

[15] People’s bank of China, http://www.pbc.gov.cn/diaochatongji/tongjishuju/gofile.asp?file=2010S07.htm