China's worst hour?

China, which has been an engine of global economic growth for the past decade, is now facing a serious threat. This development is surprising given that only three months ago it had hosted the Olympics—a $40-billion extravaganza. China’s growth, which had grown from 11.6 per cent in 2006 to 11.9 per cent in 2007, is projected to decelerate to 9.7 per cent in 2008 and further to 8.5 per cent in 2009. The deceleration has been marked in the third quarter of 2008, when it slowed to 9 per cent from the heady position of 12.6 per cent in the second quarter of 2007.

Exports have also been declining over time—November 2008 saw a 2.2 per cent fall, which was the first decline since June 2001. Imports fell even more sharply, by 17.9 per cent, partly due to a decline in international oil and commodity prices and the slowing of domestic economic activity. The Chinese government seems to have been aware of the coming crisis. Indications are that there was awareness of the flipside of having an undervalued exchange rate, overreliance on foreign investment, low domestic consumption that was sought to be made up by high dependence on exports and a high degree of financial exposure to the US economy. China began 2008 with $1.6 trillion of reserves. This now touches $2 trillion.

The country’s exports have been adversely hit by the sharp contraction in US consumption, the appreciation of the yuan in relation to the euro and Europe’s own slowdown. While China had known that it needed to rebalance its economy and move away from investment and export reliance, it did not do much during the past five years.

China has a high stake in Wall Street. In November 2008, it overtook Japan in being the largest holder of US government debt— about $600 billion. Another $400 billion is invested in mortgagebacked securities and bonds that are now directly or indirectly backed by the US government. China Investment Corporation (CIC), which manages $200 billion of China’s sovereign wealth fund, has reportedly lost about $6 billion of the $8 billion it had invested in Morgan Stanley and the Blackstone Group.

Immediate concerns
Three engines of growth, viz., exports, investment and consumption are slowing down. Real estate investment had been growing at 20 per cent per annum, but declined to zero per cent in 2008. Naturally, this has sobered demand for cement and steel, which China had been producing in plenty. Labour-intensive exports have slowed down more than the capital-intensive variety. Thousands in Guangdong Province in South China have lost their jobs as factories are closing down—many Christmas orders were cancelled.

The composition of China’s merchandise exports is highly skewed in favour of unskilled, labourintensive and high-technology products. These account for more than a fourth of China’s exports and high-tech products about a third. Together, these constitute about three-fifths of its total exports. Twofifths of China’s export basket is made up of primary, natural resource-based, low technology and high human capital intensive products. While some analysts see the presence of FDI-enabled firms in China as the major reason for China’s success in exporting high-technology intensive products, others argue that China has become an assembly platform for high-tech components being imported from its trading partners, including the NIEs-4 (Newly Industrialised Economies) and Japan. These are assembled in China and then exported. China’s share of hightech imports is more than two-fifths of its total, resulting in a significant trade deficit in this category. On the contrary, the share of unskilled labour-intensive products in China’s imports is a minuscule 4 per cent. This results in a huge trade surplus for China’s trade in this category.

China’s current economic crisis might impact its trade with India. China accounts for about 7 per cent of India’s exports and India for less than 1.5 per cent of China’s exports. More than three-fifths of India’s exports to China are made up of mineral ores, cotton and non-metallic mineral products. More than half of China’s exports to India comprise high-tech goods. A slowdown in China’s manufacturing sector would slacken the demand for import of primary products from India. Exacerbating the woes is the prospect of a further devaluation of the yuan. While the yuan has appreciated about 20 per cent since 2005, there are signs in recent times of China permitting its currency to depreciate. China has about $2 trillion of foreign exchange holdings, twothirds of it being dollar denominated. In order to provide stimulus to its weakening economy, it might sell off a large chunk of its foreign exchange reserves and pull out of its US holdings. However, this would be a difficult choice as it would weaken the dollar vis-à-vis the yuan and have an adverse impact on China’s already decelerating exports.

Prospects
China’s immediate future growth would depend on increased domestic consumption and investment. It may not be easy to enforce high consumption through convincing the households to save less. Savings are important as health and education provisions are costly and without any significant subsidies. In the case of investment, there is already overcapacity of infrastructure and new construction activity is decelerating. The current financial crisis has impaired access to trade finance. China and the US have agreed to provide $38 billion worth of trade financing during 2009. The programme would be implemented through bilateral export credit agencies in the form of direct loans, guarantees or insurance to creditworthy banks.

The Chinese government has announced a $586-billion growth stimulus package to spur domestic demand. This would be implemented over 2009-2010. It is aimed mainly at infrastructure spending. Would this create jobs? After a decade of robust growth, China perhaps has an overcapacity in infrastructure. Further strengthening may benefit through the generation of some jobs in the sector, but the multiplier effect would be much less. The key, therefore, lies in stimulating domestic consumption.

Nevertheless the “high growth” phase of China might just need a spell of cooling before it starts chugging along to reach new frontiers of economic achievement.