Beijing would have had to be an economic heavy-weight in China for it to influence national economic growth. However, its population is only 1.1% of the national total; its economic output is less than 3% of national GDP. Even if you tally up the estimated Olympic-related spending in the past four years, which amounted to a total of about $40 billion, it accounted for an average of only 0.3% of ChinaÆs total GDP each year. This is hardly significant in the national context.
Further, there has been no spillover effect on investment outside Beijing. The capitalÆs investment spending growth has been lagging behind the national average, in spite of the Olympics. In 2007, BeijingÆs investment spending accounted for only 3% of the national total, down from over 5% in 2001 and 2002. Thus, the demand for commodities and investment that is related to the Olympics is very limited to start with.
There is also a view that Beijing has been holding off economic adjustment policies until after August this year in order to keep social stability in the run up to the Olympic Games. The aim is to show the countryÆs economic achievement and prosperity. This is nonsense. Evidence since 2004 has shown that Beijing had been quick to take economic cooling measures as soon as it feels economic growth might have been overheated.
The latest round of tightening measures saw six interest rate hikes and 10 bank reserve requirement ratio hikes throughout 2007, with the severity of the tightening increasing towards the end of 2007. The central bank has hiked the bank reserve requirement ratio five times so far this year, taking the ratio to a record high of 17.5%.
There are other, more relevant, economic fundamental factors affecting the China's economic and financial outlook this year, including a decline in corporate profits, the collapse of A-share prices, a property bubble and unclear macroeconomic policy steering the country through the global slowdown. These concerns are valid, but they should not be exaggerated.
ChinaÆs overall industrial profit growth slowed to 21% in the first five months of this year from 43% in the same period last year. This sharp drop has mainly been driven by the profit slump in the oil refining and utility sectors, which account for an average 15% of ChinaÆs total industrial profits since 2004. These two sectors have reported heavy losses recently due to surging input costs (notably for oil) and government controls that bar them from raising output prices. Recent electricity and fuel price hikes by Beijing (as well as future price liberalisation) should offer some relief to these sectors, but the near-term outlook remains poor. Excluding the oil and utility sectors, industrial profit growth actually rose slightly to 27% year-on-year in the January-May period from 25% last year.
While a fall in profit growth certainly hurts stock prices, the sharp drop in A-share prices since October has mainly been a result of the asset bubble bursting. Beijing's inaction to the market turmoil has aggravated the A-share price fall by dashing hopes of any bailout measures. The current market correction process resembles the bursting of Hong KongÆs red-chip bubble between 1994 and 1999.
Arguably, the A-share price slump is a violent process of the market reverting to its long-term trend. Just as the share prices overshot their long-term average on the way up in 2006 and 2007, they could undershoot in this violent correction. But this share price correction is not an omen for deteriorating economic fundamentals in China. Historically, there has been little correlation between ChinaÆs stock price movements and GDP growth because the amount of stock is too small to generate any wealth effect or financial repercussions that could affect the countryÆs growth trajectory. For example, stock prices dropped by over 50% between 2001 and 2005, but GDP growth sped up from 7.6% to 9.9% in the same period. Also, the stockmarket had no wealth effect on its way up - the A-share price surge wasn't reflected in retail sales growth - and so should not have any negative wealth effect on its way down.
Banks and brokers cannot lend to equity investors, and no margin trading is allowed. So leveraged speculation and, hence, systemic risk to the domestic financial system from the market correction is limited. Finally, equity financing is still not prevalent among the private sector so changes in stock prices have had only limited direct impact on the cost of capital for the private sector.
There are also worries that ChinaÆs property market might follow the stockmarket into a major slump, with dire economic consequences. Indeed, property prices in some major cities, first Shanghai and more recently Guangzhou and Shenzhen, have fallen sharply. Chinese banks have a much bigger exposure to the property sector than to the stockmarket, with most banks having about 30% of their lending to property developers and buyers. The property sector also has a strong spillover effect on other demand, including steel, cement, building materials, petrochemicals, home decorations and services, furniture, appliances etcetera. The knock on effect from a property market collapse could be big.
However, these concerns are overblown. Despite rampant speculation in some cities, there is no nationwide property bubble. In smaller cities property price increases have been much more muted. There is also no evidence that housing affordability is worsening overall. Chinese banksÆ exposure to mortgage lending has been small, accounting for about 11% of total loans. A collapse of the property market is, thus, not likely.
While not all of BeijingÆs measures are appropriate from a market perspective, the government has acted swiftly to curb property speculation by various means, like raising the down payment ratio, increasing property profit and sales taxes, raising mortgage rates and restricting buying and property development by foreigners. The first city that came under BeijingÆs anti-speculation attack was Shanghai, which saw its property prices fall in the period from mid-2004 to 2006. The more recent property price drops in Guangzhou and Shenzhen have been a result of both BeijingÆs austerity measures and a knock-on effect from the slowdown in exports, which account for 90% of GDP in the Guangdong province.
Finally, there is downside risk to GDP growth in the short-term, which is causing a macroeconomic policy conflict (high inflation argues for a tight policy bias, but growth risk argues for policy relaxation). Stubborn high oil prices add complications to ChinaÆs economic environment. Until we see oil prices correct and stabilise and growth in the developed economies stabilise, there ChinaÆs stockmarkets will see more volatility with a downward bias. Nevertheless, the long-term structure of the Chinese economy remains solid. And the Olympics? It is irrelevant in affecting ChinaÆs economic and market outlook.
Chi Lo is a director of investment research at Ping An of China Asset Management (Hong Kong)
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