When China’s State Council announced a Rmb4 trillion ($586 billion) economic stimulus in November 2008, the investment surge that followed played a major role in jumpstarting Chinese growth. It also helped to restore global demand and inject confidence into largely paralyzed international financial markets.
Within 18 months, China’s economy had returned to double-digit growth, while stimulus-fuelled infrastructure and construction projects had provided employment for the tens of millions of workers in export manufacturing industries who had lost their jobs.
Other nations followed suit, enacting stimulus policies of their own. By the end of 2009, global growth rates were positive again.
But the consequences weren’t all positive. Beijing’s instruction to state-owned banks and local governments to throw caution to the wind to restore growth unleashed a flood of credit and liquidity. Although regulators have largely stemmed the flow, they are still assessing the damage.
WILL THEY, WON’T THEY?
The global economic outlook is again darkening. But with Chinese policymakers aware of the risks and rewards associated with such stimulus-fuelled growth, there are doubts over the willingness of authorities to countenance a similar rescue package should a renewed financial storm erupt.
Given China’s growing role as the primary driver of global demand and growth, the policy choices made in Beijing will have profound global consequences. The rest of the world shouldn’t necessarily be counting on a similarly large stimulus this time.
When Chinese policymakers unveiled the stimulus in 2008, they had ample resources and policy space at their disposal. A decade of double-digit, export-fuelled growth had provided the government with vast domestic and foreign exchange reserves. Government debt levels were extremely low, both at central and local levels. And the state-owned banking system had just gone through a multi-year restructuring and deleveraging process.
But three years of record credit growth and investment might now have changed this picture. “China doesn’t have the same scope now for a stimulus package as massive as the one we saw in 2008,” says Wang Tao, chief China economist at UBS and a former senior IMF economist. “In 2008, Chinese policymakers had a clean sheet to play with, but right now, after three years of major expansion, things are different.”
There has been a significant increase in local government debt since 2008. According to official statistics released by the National Audit Office in June this year, local government debt liabilities amounted to Rmb10.7 trillion by the end of 2010, equivalent to around 27% of the country’s GDP.
Wang estimates local government debt at around 30% of GDP. Others analysts, such as Northwestern University academic Victor Shih, suggest that the local government debt burden could be as high as 40–50% of China’s GDP. Fitch Ratings recently issued a downgrade warning on China’s local currency debt because of its sheer scale.
But others, such as Pieter Bottelier, professor of China studies at the Johns Hopkins School of Advanced International Studies, point out that overall government debt levels in China remain relatively low – central government debt is tiny, while the current budget deficit is running at around 1.5%, below even the official government deficit target of 2%. Accordingly suggestions that there isn’t the scope for another sizeable stimulus are wide of the mark, they argue.
“There is still enormous fiscal room in China in case you have a sharp contraction in growth. The Chinese have not run out of ammunition,” says Bottelier. “They can pull several rabbits out of hats that we can’t do in the West anymore.”
That does not mean that lending under any new stimulus package would be uncontrolled. Rather, says Louis Kuijs, chief Asia economist at MF Global in Hong Kong and a former China economist at the World Bank: “It would be much less of a carte blanche should we see another stimulus.
“To the extent that local government lending can continue, it will be much more steered and controlled than it was three years ago.”
RISK AWARENESS
So while China’s authorities still have enough space to launch another stimulus, a much greater recognition of the potential risks and negative consequences this time may make them less willing to do so.
“Chinese policymakers still have the means – they still have control over the banks and a lot of fiscal policy room to act. But the appetite for that kind of grand stimulus is a lot weaker than it was back then because the risks are far better understood,” says Mark Williams, chief China economist at independent macroeconomic consultancy Capital Economics.
Moreover, there is recognition that while the ‘spend first, ask questions later’ approach to the stimulus package enabled speedy deployment, it also meant insufficient oversight of how funds were being deployed, and contributed to overly fast asset-price growth, particularly within the property sector.
Widespread public dissatisfaction over a sharp surge in house prices in 2009 and early 2010 and a string of high-profile, infrastructure-related disasters – most recently a high-speed rail crash in the eastern province of Zhejiang in July that killed 39 people – have been linked to the previous stimulus.
“The government’s top priority is social stability, and lessons have been learned from the previous stimulus,” says Wang. “Many people in China felt that, while the stimulus brought about very nice GDP growth numbers, it also had undesirable side effects – asset-price inflation, low-quality construction, social issues. These are still being felt, so I think that the government will be careful not to put too much emphasis on growth at the moment.”
HOME FRONT
While the gathering global economic storm may bear many of the hallmarks of that seen in 2008, today’s domestic situation in China is different.
In 2008, excessive property and credit tightening had resulted in a major reduction in domestic demand and industrial output even before the drop-off in export demand and the collapse in global growth.
“Many forget that China’s real economy was in dire straits prior to the global crisis in 2008,” says Kuijs. “We then had this dramatic slowing down of exports that came on top of a very weak property sector.”
Despite administrative measures over the past 18 months to contain property prices through restrictions on second-home purchases and mortgage lending in some overheating markets, property demand has remained strong. Furthermore the government has embarked on an ambitious affordable housing buildout, bolstering construction demand and activity.
“The most important difference between now and 2008 is that the property sector has been holding up well, and heavy industry demand is solid. If we have a similar collapse in exports to that seen in 2008 in the next few months, China’s overall economy will be less affected than it was three years ago,” says UBS’ Wang.
Exports are now less important to the overall economy, both as a proportion of GDP and in terms of their contribution to growth. While this is largely a result of stimulus-backed investment growth rather than consumer spending, this is indicative of a gradual shift of the Chinese economy to becoming more domestic demand driven.
This increased domestic focus is, in part at least, in line with broader, long-term development goals. When Chinese premier Wen Jiabao unveiled the 12th five-year plan, he emphasized the importance of expanding domestic demand, outlining a lower annual GDP growth rate of 7% over the next five years, with household consumption and the service sector playing a larger role in this growth.
The government may therefore have more tolerance now for a slowdown in headline growth rates than it did in 2008.
“The 12th five -year plan gives the government the political cover for a slowdown in GDP growth to 7% or even slightly below, so drastic policy action really doesn’t become an agenda item until growth falls to 3–4%. Then they have to do something,” says Bottelier.
But there is also reason to be sceptical about the government’s appetite for slower growth. While the growth target in the previous 2005–10 five-year plan was 8%, growth far exceeded that rate over that period.
Employment, not GDP growth, is the government’s primary concern, says Andy Rothman, Shanghai-based China macro strategist at CLSA. “There’s no question that the Communist party is happy with a slightly slower level of growth, but the key determinant of whether a further stimulus will be necessary is not going to be a macro statistic like GDP growth; it’s going to be employment,” he says.
Rothman dismisses the notion that rising levels of local government debt would prompt the government to hold off on a sizeable second stimulus. “If a significant number of migrant workers in export processing businesses lose their job, as happened during the second half of 2008, the government won’t hesitate to announce another stimulus designed to create temporary employment for them, as it did last time,” he says.
But if the government deemed it necessary to launch a second stimulus, Rothman says, it would likely take the form of direct central government fiscal spending, rather than be channelled through the banking system and local governments, as in 2008/09.
The government would likely fund a sizeable chunk of a second stimulus package with government bonds, says Wang. Likely target areas include an acceleration of social housing construction, an emphasis on water and environmental infrastructure projects, and a greater focus on healthcare and education spending.
Such centrally funded investments may be in line with the government’s longer-term development goals, but their effectiveness would be less immediately felt than with the physical transport and infrastructure investments that formed the bulk of the first stimulus package, experts warn.
“If a lot more of any stimulus that comes is delivered through fiscal policy, it will come much less rapidly, so you won’t have that immediate jolt to the economy that you had last time,” says Williams. “As early as March 2009, Chinese data had already started to turn around, as the investment stimulus started to kick in almost immediately. We are less likely to have that kind of jolt this time.”
GLOBAL SAVIOUR
This could have major ramifications for regional and global economies. “Because China’s stimulus came in very rapidly and was very large, it did a great deal to shore up confidence in the region,” says Williams. “On the back of the Chinese stimulus, a lot of other Asian countries brought in their own stimulus packages, so it multiplied around the region.”
China’s growth and trade numbers have remained strong, and for now the consensus view remains that a repeat of the collapse in trade and investment on the scale seen in late 2008 is unlikely. But rising risks to the global outlook will pose significant challenges in the months ahead.
Kuijs believes policymakers worldwide should be genuinely concerned about the prospect of a smaller or delayed response from China should global economic conditions worsen. “In the event that a new downturn of similar magnitude were to occur, a scenario that is looking less and less hypothetical by the day, there is a fair risk that China’s response may not be as big as it was. That’s a risk that it’s right to be worried about,” he says.
And while stronger domestic demand may cushion some of the blow domestically, the rest of the world should not expect China to come to the rescue once again should conditions worsen significantly.
“China may not have saved the world last time, but it saved part of the world – commodity exporters and countries that export capital goods,” says Wang. “China’s domestic demand is strong, so there is a floor there if things worsen again, but at the same time don’t expect China to come up with major additional demand for the rest of the world.”