China GDP: less will be more

Standard Chartered Senior Economist Chi Lo outlines his radical views on why China will benefit from lessened GDP growth of 6% in 2002.

FA: How do you think accession to the World Trade Organization, scheduled for the first half of next year, will affect China's GDP growth rate?

Chi Lo: I think it could fall to as low as 6% next year. But I don't see this as negative. The whole point of joining the WTO is to increase efficiency. China will be going on a diet, as it were, and the growth that does materialize should be far more efficient. So far, a lot of the growth has been provided by massive government spending, which is not necessarily the most efficient way of producing growth. Having said that, government spending has been crucial and constructive in building China's roads, transportation channels, and other forms of economic infrastructure.

What do you think the will happen to the Chinese yuan?

I am not concerned about the RMB in the short-term (next 12 months) because positive balance of payments pressure, mainly from strong capital inflow, is expected to continue to support the yuan. But the Chinese unit could face a long-term weakening trend. In the wake of the World Trade Centre attack in the U.S, China's export growth will come under further pressure on the back of an already weak global economy, especially given that consumer goods form the biggest part of China's exports.

Unfortunately, consumers in the US, China's biggest export market, are likely to be tightening their belts and buying fewer consumer goods. On the import side, we can expect continued strong growth in imports after China joins the WTO, due to rising demand for industrial upgrading and reduction in import tariffs. All this increases the risk of a current account deficit next year and later. On the capital accounts, FDI has been strong but it's probable that it wouldn't be strong enough to prevent the balance of payments from worsening, thus causing the yuan to lose strength, after 2002.

How much would the yuan weaken, and would it be a net positive or negative?

After WTO entry, I expect the People's Bank of China to widen the yuan's trading band to 5%. (The currency currently trades 0.3% either side of 8.2766). However, it's highly unlikely that there will be a repeat of other failed emerging markets devaluations, (going into freefall) due to the PBOC's control over trading. And China's lack of foreign debt will mean that there won't be a repeat of Thailand's disastrous devaluation in 1997, which was triggered by massive withdrawal of foreign creditors.

On the whole, widening the band will be net positive for China, since with a more flexible yuan policy, China will have more tools to balance the economy, although this doesn't include competitive devaluation with its neighbors. In the short-term, China will not want to squander the political goodwill it built up when it didn't devalue during the Asian Crisis of 1997/1998.

Are you concerned about China's fragile banking system?

Not only foreign investors, but also the Chinese leaders are concerned about China's fragile banking system. But China's financial system has one major advantage, at least in the short-term, over other Asian countries, which were devastated by the Asian Financial Crisis of 1997/1998. Most Asian countries had weak banking systems, but they were also exposed to massive foreign capital outflows because of their high level of foreign debt. Fortunately, China's foreign debt is minuscule, so the country's banking sector cannot be held hostage to the withdrawal of foreign creditors.

Unless Chinese consumers panic?

That's the Achilles heel. But that prospect is highly unlikely. A serious bank run would represent a total collapse of the system, and the Chinese leadership is determined to prevent that from happening, especially in the run up to next year's leadership change.

What about China's efforts to hand over corporate debt to the asset management companies?

These AMC are currently merely debt warehouses. They have had no success in selling the debt to domestic or foreign investors. Unless the debt can be sold, the bank restructuring process is only half-baked, although it does get the debt off the banks' balance sheets, so improving their capital ratios. Due to the tremendous amount of legal and institutional changes that are needed to facilitate proper functioning of the AMCs, it will take a few more years before we can see China's AMCs function as the US RTC that helped turned around the US Savings & Loans crisis in the early 1990s.

How close have the authorities come to solving the over capacity and deflation problem?

China has been out of the deflation trap since late last year, and inflation is ticking along at just over 1% this year. The Chinese authorities' reflationary measures are bearing fruits, as there is a clear trend of increased consumer spending and lower bank deposits growth. So consumer demand is strengthening. Over-capacity is a long-term structural problem that needs structural policy to correct. The domestic reform programmes are designed to solve this problem, while entry to the WTO will help speed up this process by forcing Chinese managers to produce goods and services that meets market demand but not just for production's sake.

What about the Taiwan reunification issue? Is there a serious likelihood of conflict?

Like all armies, the PLA wants to justify its existence by constantly emphasizing the need for a violent resolution to problems. But the PLA is under the thumb of the political leadership. The most obvious sign of this is when the PLA was ordered by President Jiang Zemin to remove itself from the massive business empire it had set up. Incredibly, the PLA complied without murmur of dissent.

As for the 'one country' formula, I don't believe Taiwan and China are that removed from a resolution, in principle. There's a lot of 'face saving' going on both sides and nitpicking over wording. There's also a generational aspect, whereby the older Taiwan generation is still extremely suspicious of the Communists. However, as the next generation comes to power, we could see a change in Taiwan's policy on the issue of 'one country'. Increasing economic integration with the Mainland will also form the foundation for political talks in the coming years. We already are seeing rapid progress toward the establishing of direct economic and transport links between China and Taiwan.

Share our publication on social media
Share our publication on social media