22 January 2010


In the midst of a massive once-in-a-century global recession, and with its exports down by 16% (about $250 billion, 5% of GDP), China has still managed to deliver GDP growth of 8.7% in 2009, almost on a par with 2008.

From a weak start in early 2009, growth heated up fast to a racy 10.7% by the fourth quarter, reminiscent of the run of double digit peaks seen prior to 2008. At almost $5 trillion, GDP will surpass Japan while exports of $1.2 trillion will push Germany into second place in trade.

Policy-makers did not stint in delivering the stimulus needed to guarantee this sizzling performance and maintain confidence: this left no one in any doubt that growth was assured. There have also been benefits for trade partners from the revival in import growth, bringing China's much criticised trade surplus down from roughly $300 to $200 billion. And with the world looking more stable and China growing robustly, even exchange rate policy is expected to relax before long - going back to a crawling revaluation against the dollar after the freeze put in place in the mayhem of late 2008.

Round of cheers and pop the champagne corks? What about the risk of overheating? What about even larger currency appreciation?

China is used to the developed world's carping about its economy and policies. This must seem unfair.

In periods of turbulence, not only now but also in previous recessions and during the Asian crisis of the late 1990s, China has kept growth going and maintained financial stability in the midst of mayhem, helping the region as well as itself. The handling of its economy - and guarding the renminbi-dollar peg - during the Asian crisis won some praise. But notably it also elicited scepticism about its foundations. There was also scaremongering about the threats posed by China's banks in the late 1990s, the rise of inflation in 2007-2008, generally excessive dependence on export led growth and so on. Each threat has been overcome, failing to perturb China's growth record. This time round, there have been various claims of statistics rigging and predictions of calamity but, as 2009 came to an end, complaints have focused sharply on the issue of overheating risks and asset bubbles. While the rest of the world worries about the global recession's prolonged chill factor, it seems that China is like chilli - too hot for comfort.

Is this fair - is there good reason to be concerned?

The world has just been through a once-in-a-century recession, with every region of the global economy affected by the synchronized collapse in trade as well as widespread financial turbulence. World trade probably dropped by around 20% ($3-4 trillion) in 2009. In these circumstances, it was expected that Asia would be particularly hard hit by the losses in world trade, reflecting the slump in import demand in its key US and European trade partners.

Asian exports did plummet in late 2008 and sales remained weak through most of 2009, especially to the US and European markets. This was also true for China: Chinese exporters' lost almost $250 billion in revenues (about 5% of GDP) as sales dropped by 20-25% in early 2009 and only picked up in the last months of the year. A pick up of 17.7% (year-on-year) was reported for December but this only took exports back to around the level seen just before disaster struck in the last quarter of 2008. Although the 11% fall in imports helped offset the effect of export losses on GDP, the drop in net exports was still some $100 billion, roughly 2% of GDP. After adding to GDP growth in previous years, trade became a drag that had to be offset by domestic demand - yet China not only delivered this offset but scored an additional 8.7% rise in GDP.

It could be said that China's fiscal package (estimated to be worth about 15% of GDP over two years) and the engineered surge in bank credit (up by about 30% in 2009) over achieved. Success was expensive and came with risks attached: much of the extra liquidity leaked into speculation in the stock market and property, stoking asset price inflation.

With hindsight the economy may have been comfortably rescued with a more modest package - arguably 20% credit growth might have been less dangerous and sufficient to push GDP growth above 8%. However, estimating policy responses precisely, especially in the midst of such chaotic world conditions, was impossible. No one could accuse China of failing to respond as they put on a formidable display of economic power.

Is this overachievement really so dangerous?

There is unlikely to be a serious outbreak of consumer price inflation. Although prices are now up nearly 2% year-on-year after seeing deflation through most of 2009, this is hardly a worrying rate and reflects the comparison with the period of price declines seen during the worst phase of the global recession. Other countries are also seeing a rebound in inflation to more normal annual rates but this will not pose a serious threat as wage demands remain modest, damped by high unemployment, and key commodity prices have roughly stabilised at lower levels than the 2008 peak. The risk, if any, in China and elsewhere is from the impact of low interest rates and easy money on asset markets, especially equities and property.

China, like the US and Europe, faces a dilemma over tightening policy to control surging asset prices. They could act but are still wary about a potential impact on the real economy and growth. However, the constraints in China are less given its strong economic performance as well as the authorities ability to control credit, which means that this 'tap' can be turned on and off directly, probably more effectively than through adjusting interest rates (although these should ideally be set to balance the economy rather than offer credit too cheaply). It seems likely that the real economy can progress well even if credit growth is reduced - after all, much of the very large increase in credit in 2009 went into asset markets and not into real demand in the economy. This is a lesson for 2010 that is already being acted upon as the authorities raised prudential reserve ratios for the banks this month.

China's critics will never be silent, and scaremongering about asset bubbles looks set to continue for a while yet, until a new threat emerges and takes over the headlines.

In conclusion, what lessons can be drawn from 2009? China proved, yet again, that it is recession proof, even withstanding a once-in-a-century global shock to achieve GDP growth of near 9%. But in achieving this feat, has it come dangerously close to blowing itself up amidst bursting asset bubbles or is this scaremongering? While China could go it alone through the recession, during the recovery years it will become increasingly vulnerable unless other economies help to sustain momentum. As long as exports pick up and relieve the strain on policy, China can act decisively to damp down asset price inflation without the risk of derailing GDP growth. China should be given the benefit of the doubt in managing its economy - most probably it will achieve another safe landing even if it has sailed closer to the rocks than usual.