SEOUL, KOREA -- Debate is heating up on the hard and soft landings of the Chinese economy. Following international projections that China’s growth rate will hover at seven percent in 2012, the media is rushing with reports declaring: “China, too, is in trouble!” So what is happening in the Chinese economy
In China, policy has the upper hand on the market as the government’s decision is the utmost priority. It is often far off the mark when you view China from a western point of view. Under a façade of market economics, China operates a particular “Chinese Socialist” market economy which is controlled by the “visible hand” of the government.
This explains why China’s economic cycle is closely linked to its five-year political cycle coinciding with the tenure of the country’s supreme leader. In the last 30 years, the economic growth rates during the tenures of Deng Xiao-ping, Jiang Zhe-min, and Hu Jin-tao show a typical 'strong beginning and a weak ending'. Chinese leaders hold the office for 10 years because they normally stay in office for two terms. In general, the economy's growth rate during the first term is higher than that of the latter 5 years of their tenure. 2012 will be the last year of Hu Jin-tao’s administration as China will transition to the Xi Jin-ping administration in October.
China’s Central Economic Work Conference (CEWC) - where the central government’s work is reported and economic plans are made for the upcoming year - ended a few days ago. This conference set the direction for major economic policies for 2012, and once the detailed policies for the various departments are complete, the official economic policies will be decided at a council conference to be held in March.
The current perception is that the overall tone of the policies will be an extension from 2011. The meeting of the Central Committee of the Communist Party, prior to CEWC, revealed the key concepts for 2012 economic policy: stabilization of growth, advancement of industrial structure, protection of people’s livelihood, and promotion of social stability.
Forecast on China’s "crisis" and its intent to buy sovereign debt
China is “built on quicksand” and “could be more dangerous than Europe,” say James Chanos, an owner of a hedge fund company, and Marc Faber, the prophet of doom. Can American and European experts who don’t speak Chinese, have never lived, studied, or worked in China really predict the Chinese economy Do they - foreigners who hardly visit the country three times larger than the US and twice than Europe, grasp objectively the complex situation of China
“Houses are built with sand these days” and there is no desert or sand in the east and south of China where the Chinese population is concentrated. China is unlike European governments that spend enormously through debt and have 9-10 percent of budget deficit from uncollected taxes. In fact, China’s revenue growth rate is three times higher than their GDP growth rate.
Whereas in Europe, foreign investors hold government bonds, and, thus can decide the survival of a country, most of China’s bonds belong to Chinese organizations. The public may be poor, but as a nation, China has more money than any other country in the world. That is why there is no risk of sovereign bankruptcy like in the US or Europe.
According to the Sovereign Wealth Fund Institute, last year, China’s sovereign wealth fund (SWF) – China Investment Corporation (CIC) - became the fifth largest SWF in the world with USD 400B. And the return on international investment on CIC was 12%, which is significantly higher than that of Morgan Stanley Capital International’s 9.6 percent.
As if this were not enough, the Chinese government recently announced that they would create SWF’s of about USD 300B which would be invested specifically in the US and Europe by taking advantage of their abundant foreign reserves. Bizarre as it may sound, China is setting up a fund to buy insolvent obligations from the US and Europe.
Predictions on the Chinese Economy for 2012
Chinese economy in 2012 will not be able to avoid decline due to the usual downhill of the five-year political-economic cycle of the country as well as the economic recession of the US and Europe. The degree and scale of the downturn, however, is debatable. International organizations like the IMF suggest the highest growth for the Chinese economy in 2012, followed by followed by research institutes inside China. Foreign researchers paint the most pessimistic pictures.
The lowest expectation of Chinese economy, i.e., the growth rate, in 2012 is 7.5 percent and highest is 9 percent; international organizations say 8.8 percent, foreign institutes 8.2 percent, and Chinese institutes 8.5 percent. As I have mentioned many times in this column, there will be a war if the growth rate of China falls below 7 percent. But China currently has too many tools it can use for stimulating the economy using its fiscal and monetary policies.
Although the growth rate of China’s GDP is around 9 percent, its revenue is increasing by 30 percent every year and the budget deficit is only at 2 percent, which can be controlled by the government. Considering the 8 percent growth rate three years ago and China’s present infrastructure, the country will have a difficult time supporting the economy if the number falls lower than 8 percent. In other words, China will have to, at all cost, maintain it around 8 percent in 2012 as well. We can expect the overall rise of the economy being the lowest in the first and second quarters and fourth, the highest.
The real reasons behind the downturn of the Chinese stock market in 2010 and 2011
South Korea’s economy depends the most on China, but Koreans also have the most intense love and hate relationship with their northern neighbor because investors suffered huge losses from Chinese funds. No other country has such a big disparity between its stock prices and its economy. Many people turned their backs on China because the country’s stock prices plummeted despite the good economy.
But why
First, China is not a simple “market economy”– you need to add “Chinese Socialist” before the phrase. It is not the market but the government policies that determine the economy. We need to put greater emphasis on the policies than on the economy. We may better understand the fall of stock prices if we examine the significance of China's monetary policies rather than just its growth rate.
Second, it is a question of investments. Major Chinese funds in Korea chose mobile telecommunications, banks, chemical and steel stocks as their main investments in China. Imagine what would have happened if they had bought steel and telecommunications stocks in the Korean stock market for the last two years
Yet another major reason that the Chinese stock market ‘dropped’ despite its strong economy lies in the pressures on supply. The government directed financial institutions to increase their capital on a large scale for financing, which made the stock market a virtual ATM for the financial institutions which “drained the liquidity.” That is why the stock market was left cold despite China's sizzling economy.
In a bid to boost the economy amid the financial crisis, the provincial governments raised capital through local major state-owned listed companies and set out huge new projects. However, the manufacturing industry could not support the increased pressure. The figure below shows the financing by China’s stock market. Even though the Chinese stock market fell rapidly, the country raised more finance in 2010 than in 2007 before the financial crisis. In addition, preparing against the effects of economic stimulation enabled by CNY 10 trillion-loan, the Chinese government ordered a capital increase and IPO for all banks and supplied an enormous amount of funding, the side effects of which were manifest in 2011.
Chinese stock market -- key points in 2012
Once again in 2012, it is not economic growth but “liquidity” that we need to keep an eye on in the Chinese stock market. Given the nature of the Chinese economy and economic leverage of the government, a hard landing is unlikely, contrary to the West's concern.
The government’s position on the monetary policy of CEWC is important. Also, China is preparing for economic stimulation against the recession caused by the crisis in Europe. However, it will not be the same kind of ‘engineering work’ as in 2008 - because, after the ratio of fixed capital investment in real estate to GDP passed 8 percent, recording the highest in history, the government will no longer be able to increase their investment in this area.
The key to the Chinese stock market in 2012 will be the government’s financial policy. The pressure on supply caused by increased capital is somewhat resolved and the valuation is at the lowest level in the past 15 years. We need to read between the lines on CEWC communications: an active financial policy and a moderate monetary policy.
The real liquidity of the Chinese stock market clearly reveals the power of the government’s financial policy. If the real liquidity turns negative like in 2007 and 2011, it is hard to expect the stock market to rise. With stable prices, around 14 percent of money supply increase, and the economic growth rate at more than 8 percent, the real liquidity will turn positive again in 2012. The Chinese stock market should be read in the context of the Chinese market’s financial condition.
Chinese government decided to shift the focus of their economic policies for the next five years from real estate investment and export-oriented growth model to high-tech industry investment and domestic consumption. The investment plans of each department following CEWC will probably show promising industries for investment. The investment plan for the next five years announced by the government amounts to CNY 22 trillion (KRW 3,566 trillion), which means over CNY 4 trillion per year.
Chinese stocks that have led the Korean stock market for the last two years will go through a change as well. Although the policy support for falling cars and home appliance stocks and booming real estate have resulted in great reward from the major Chinese stocks – automobile, chemical, oil stocks - in Korea, subsidies for home appliances and automobiles are coming to an end and the real estate market, too, is on the decline. China-related stocks that dominate the Korean stock market will also move from car, chemical, oil industries to “new consumption” industries and “seven strategic industries for new growth,” with which Chinese government is seeking a new path to further development.
One of the most important matters during the latest central government’s conference was to “increase the proportion of the middle class.” Enhancing the middle class is essential for the country in turning from an economy of production to an economy of consumption. In an attempt to encourage the Chinese public who saves 50 percent of their income to spend more, the Chinese government has embarked on structural tax cuts and building a social safety net.
Apart from raising tax exemption limits for individual income taxes and reducing the tax burden by adjusting value added tax rate on service industries, the government implemented the minimum wage law in major cities and is encouraging a two-digit wage increase. Moreover, by forcing companies to guarantee the five social insurances, China is setting up a social safety net for individuals with the corporate money while promoting employment stability by making permanent employment mandatory when a company hires the same person twice or more.
Now, it is no longer about taking advantage of low labor costs and operating local factories in China. From now on, companies who can materialize the economy of scale by targeting domestic demand rather than manufacturing export will survive in China.
The fact that China is turning into an economy based on domestic demand and consumption is favorable news for the stock market in a sense that it will stop the government from withdrawing capital through state-run companies based on manufacturing. This can actually have bigger practical significance than the direct effects of policies, because the stock market can naturally rebound once it stops acting as an “ATM for state-run companies” like it has been for the last two years.
In any case, real liquidity is of the essence in the Chinese stock market in 2012. The economic growth may slow down, but if the prices fall and monetary growth rate rises slightly, then real liquidity is likely to turn positive. Because of the pressure of inflation, China’s monetary policy cannot change much at the moment but the tone of policies can change towards the second half of the year. Chinese IBs are expecting stock prices to be around 2250-3050.
