A year of being dull, for a change - a macro-economic overview of China

Fast growth, low inflation and a crawling Chinese yuan are on the agenda for 2006, with the Chinese currency rising and fluctuating more as market reforms advance. The risks of a sharper slowdown are concentrated in 2007-08.
It looks set to be a really dull year for China in 2006. But dull in a good way. Gone is the excitement of 2005, when analysts battled over the renmninbi, when inflation hawks worried about huge foreign exchange inflows, when Jeremiahs rumbled on about a hard landing and we all worried late into the night about US-China relations. In the end, the renmninbi question now looks settled, inflationary pressures have dissipated, foreign exchange inflows appear to be slowing and analysts are still waiting for a significant landing of any sort. And US-China relations, at least as far as the renmninbi is concerned, look a bit healthier too.

China Remains AsiaÆs Growth Champion

China looks set to grow faster than any other country in Asia, again û we are looking for 9.8% real growth on top of the Rmb18.2 trillion ($2.3 trillion) output in 2005. Figure 1 shows the revised growth in gross domestic product (GDP) on the production side, compared with the previous unrevised rates. The new figures not only raised ChinaÆs GDP by about $300bn, but also raised the annual growth rate over the last decade by about half a percentage point. Our in-house freight index, which we use as a proxy for overall growth, strengthened in 2005 from the half-year figures for 2004, as Figure 2 shows. It now signals stable growth, above the average rate over the last five years.

First quarter GDP growth of 10.2% showed there is no ebb in the momentum of growth. Indeed, we think this economy is growing substantially faster than the official figures suggest û perhaps some 12% a year at present.

Fixed-asset investment looks steady, thanks to a smaller investment deflator and ample credit being available. Figure 3 shows it coming off its peaks but remaining strong. But we suspect it will weaken in real terms given slowing profit growth and weaker export demand as the year progresses. But investment will clearly not collapse. Fixed-asset investment grew 25.7% in nominal terms in 2005, compared with 26.6% in 2004. Construction investment will continue to grow, but a little below the 28% year-on-year in nominal terms in 2005, as China renovates its cities. Urban investment rose at 27.2% in 2005 in nominal terms, compared to ôonlyö 18% in rural areas.

Consumption also looks strong, as Figure 4 shows. Urban household expenditure was growing more strongly in real terms than at any time since the mid-1990s. Urban disposable income rose by 9.6% in real terms in 2005, up by 1.9 percentage points on 2004. And the real estate deflator rose by 7.6%, adding wealth to household balance sheets. Even ShanghaiÆs residential transaction volumes revived in the fourth quarter of 2005 after a six-month hiatus. Elsewhere, expect house price inflation to match nominal economic growth. This and other consumption drivers û lower rates of unemployment, real wage growth in the manufacturing sector and a general sense of optimism about the countryÆs prospects û will remain in place in 2006. Year-on-year inflation, according to consumer and producer price indexes, have stabilised at low levels, with food prices having stabilised and more raw materials supply coming on stream.

From a policy perspective, the major theme of 2006 is clearly the countryside. Beijing, aware of the importance of rural-urban inequality is already spending vast sums on the countryside and has achieved some notable successes already û scrapping the agriculture tax and reinforcing free primary school education in rural areas are the two most important. Subsidies are increasing rapidly, mostly in rural infrastructure, but household subsidies are now increasing too. If overall growth were to slow, job growth would slow, migrant labour wages could fall back in real terms after recent gains, and the stresses in the countryside would increase. With reports of increasing disturbances in rural areas the government is clearly anxious not to allow this to happen.

On the renmninbi, most onshore economists believe that the exchange rate against the US dollar will move by 3% over the year, carrying on the trend seen since the one-off revaluation in July 2005. Our year end forecast for 2006 is 7.85%, with the pace of appreciation and volatility increasing as the market-maker system and forwards market mature. The renmninbiÆs nominal effective exchange rate shows considerable strength against the euro and the yen in 2005 (as the US dollar strengthened), as Figure 5 shows. Given the competitiveness of Chinese exports, it will take a much more aggressive move to bring overall export growth below 15% year-on-year. Widening the official band to plus or minus 1% or even 3% (from the current plus or minus 0.3%) will probably happen sometime later in the year, and would go some way to respond to overseas pressure û threats from the US Congress are largely bark and carry no bite. Do not expect Beijing to bow to outside pressure. This ôGreat Crawl of Chinaö will be sure and steady.

The Test Will Be 2007-08

So, in 2006, expect more stories of China growing strongly. The more exciting story is around the corner in 2007-08, when deflationary pressures from over-capacity may come to the fore, export markets may slow as global liquidity dries up, and greater numbers of new non-performing loans may start clogging up ChinaÆs banking system again. We do not expect a rout, but these factors could combine to drag real growth down to the 8-9% range. This could get quite exciting û but not in 2006.

The above article was written by Stephen Green, senior economist, China, Standard Chartered Bank

First published in Standard CharteredÆs Guide to China Supply Chain Management and Logistics 2006/2007

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