|Date||December 6, 2011|
|Speaker||Steven BARNETT(Assistant Director, Regional Office for Asia and the Pacific, IMF)|
|Moderator||TAKAGI Seiji(Director, Northeast Asia Division, Trade Policy Bureau, METI)|
China has had an amazing economic success story. I will provide perspective on this significance, discuss economic developments in China, speak about rebalancing, and then present how China's policies affect Asia and the rest of the world.
China has averaged almost 10% growth over the last 20 years. However, we must keep in mind relative income levels. China has grown rapidly, but its per capita income is still 10% that of the United States. It has seen a substantial reduction in poverty. The poverty rate in 1990 was about 60%, and now it is around 15%. We have seen reductions in poverty throughout the world, but nothing as steep as what is seen in China. Measuring poverty at $1.25 a day, 475 million people were lifted out of poverty in China between 1990 and 2005. China accounts for about one-quarter of global growth, mechanically, this is more growth than the United States—although much of it stems from exports to it.
How important is China? Looking at GDP on a purchasing power parity (PPP) basis, its share of global output has gone from 4% in 1991 to 14% in 2010. In comparison, Japan has gone from 10% to 6% in that same period. Measured with market exchange rates, China has gone from 2% to 9%—about the same as Japan, which has gone from 15% to 9%. In terms of GDP per capita, it is still below $5,000 per year based on 2010 figures, which is about half of the per capita GDP of BRICs, and is in line with other countries in emerging Asia. The developed parts of China are along the coast, with income per capita in Shanghai and Beijing over $10,000.
The IMF releases its flagship World Economic Outlook (WEO) twice a year. Between October and April of this year, the IMF view of growth projections worsened by about half a percentage point. U.S. growth was reduced by at least a percentage point. We are seeing a two-speed recovery, with advanced markets in the slow lane and emerging countries in Asia in particular in the fast lane. GDP in the world has not yet recovered to pre-crisis trends, and it is not expected to do so except in emerging Asia, where coming into the crisis and excluding China, it was arguably overheating. The region, including China, looks to be a relative bright spot. For China, the IMF expects growth this year to be 9.5% and next year to be 9%. When the global economy was at its worst in 2009, growth in China was 9.2%.
How much is trade contributing to growth? It has been helping to drive it, adding an average of a couple of percentage points. During the economic crisis, the decline in trade knocked 6% off of growth. Why is the economy holding up so well? Public demand and stimulus. China's response was bigger and quicker than anywhere else in the world—its stimulus was large and successful.
After the collapse of Lehman Brothers, private investment fell, while public investment increased about 60% year-on-year. This helped maintain growth. Public investment has now fallen sharply as private investment has picked up. Looking at the media, it seems that most are saying the country is either overheating or having a hard landing. I do not believe that either of these problems is occurring. There have been cost-push pressures and producer prices have been rising, but profit margins have held up and continued to rise despite these pressures. Data suggests that nominal wages are not rising very fast relative to historical patterns. At the moment, the country still has plenty of excess underutilized labor so it is unlikely the country will see overheating due to a wage-price spiral. Furthermore, China has been below output potential consistently in the past, suggesting that there is no concern of it overheating due to an output gap. What about inflation? Inflation is mainly the result of food prices, and it has already peaked at around 6% and has started to come down. Non-food inflation has never gone above 4%. It is likely that food inflation is the result of supply shocks, not a sign of overheating. Non-food shocks are a better indication of overheating, but viewed historically, except in the mid-nineties, the country does not have a history of this. What about increases in the money supply? At least historically, there is no strong correlation between money supply and inflation. It is all coming from food prices, which are primarily related to supply shocks. With food prices unwinding, the IMF expects inflation to fall to 4% this year and then to about 3% in 2012.
How have credit growth and the stimulus affected the country? The stimulus was partly on and partly off the budget. During the height of the global financial crisis, new lending in China was 30% of GDP, which is more than double at what it typically runs. Lending during this period drove growth. Since then, credit growth has gone down, although it is still a bit higher than before the crisis. We have seen a steady tightening of monetary policy. Reserve requirements were increased and interest rates were pushed up.
One of the innovations we have seen in China is that credit has started to move outside of bank loans. Insurance companies are making loans, trust loans exist, and so on. The press and economists tend to focus mostly on bank loans, but if you look at social financing, on which the People's Bank of China focuses, total credit has not slowed. Other forms of financing have made up for slower bank lending.
Is there a property bubble in China? The real estate market is complicated, but I would argue that there is no bubble. About 20% of total credit is real estate, which accounts for about 25% of GDP. There is not a great amount of data about the level of household leverage, but it is generally understood that many people buy their houses with cash, while those who use mortgages finance about 40% of the value of their homes. Looking at how affordable housing is in terms of annual household disposable income, China as a whole does not look so bad, but in certain markets such as Beijing, housing is certainly unaffordable. I would argue that it is not a housing bubble but a social problem, in which people living in certain cities cannot really afford housing. However, the gap between rental prices and purchase prices is closing. The government has been working to slow down the real estate market. The fundamental problems are very low interest rates (deposit rates are often negative in real terms) and closed capital accounts—the bottom line is that real estate investment looks very attractive. Finding alternative investment vehicles is critical to preventing bubbles in the housing market.
Looking at trade, export growth has dropped dramatically, 6-7% in October, primarily due to export growth to the EU turning negative. Next to Asia, the EU is the most important trading partner for China. Imports are holding up well with momentum picking up. With imports accelerating and exports slowing, the current account surplus is shrinking. China is exporting to Japan, Asia, the United States, and the EU, although much of the exports to Asia create products that eventually end up in the United States or the EU. China is mainly importing commodities, machinery, and equipment. There is the sense that China is just an assembler, which is true to an extent, but if one looks at how much domestic content exists is in the assembly trade, it has risen from 15% about five years ago to 40% today.
Looking at the current account balance, it fell during the crisis but is starting to recover. The IMF has traditionally predicted higher current accounts—we are almost outside of the consensus band. We feel that the downturn in the current account surplus is cyclical, and that it reflects the slowing of the global economy. We believe this process will unwind as the global economy recovers. Our baseline projection shows a re-emergence of current account surpluses. The IMF became curious about why we were projecting a current account surplus when no one else was, and so we ran models to check our projections. If anything, they showed a more rapid return to a current account surplus.
Since January 2009, there has been a gradually strengthening of the RMB against the U.S. dollar. Looking at the trade-weighted exchange rate adjusted for inflation differentials, there has been relative appreciation since 2005, when China announced a great exchange rate reform—about 5% per year. If one could borrow at LIBOR and invest in Shibor, it would be a great bet.
Shifting to rebalancing, the issue here is global rebalancing—basically a smaller current account deficit in the United States and larger current account surplus in China. The fund is also interested in rebalancing within China, away from exports to domestic consumption. Consumption share in China has been steadily falling and is now extraordinarily low by international standards. China's export growth by international comparison does not look that unusual, but market penetration does. Because China's economy is so big, its market share is expected to reach very high levels. Looking at consumption in China compared to the rest of the world, it has the lowest consumption to GDP ratio across the globe. Conversely, its investment per GDP ratio is the largest. Much of that investment is going into the export sector as well. The issue of rebalancing is all about reversing these trends. The Chinese government is committed to this, although there may be disagreements on the pace or exact measures.
I will address a few quick questions before opening the discussion.
First, what happens to Asia if the global economy slows? Assuming that European growth slows by 3.5%, U.S. growth would fall by 1%, Japan's growth will slow by 2% for a year and 1% after that, and growth in China will fall by 4% after two years. This assumes no policy response in China. This would have happened in 2009 had China not implemented a massive stimulus.
Next, how does a stimulus in China help the region? Suppose there is a stimulus set at 2% of GDP in China, in emerging Asia and Japan after two years, growth would go up about 0.25%. If China did an 8% stimulus, Asian growth would increase by 1%.
Looking at what happened during the last crisis, the IMF tried to understand how dependent economies were on Chinese final demand. We found that the more dependent an economy was on China during the crisis, the quicker it recovered along with Chinese growth. As far as China's impact on prices, China is a big importer of certain commodities—it imports 65% of the world's iron ore, 50% of its soybeans, and almost 30% of all metals. Looking at China's impact relative to the United States on commodity prices, we found that shocks in China matter, but not as much as those in the United States.
In addition to currency appreciation, rebalancing also requires strengthening the social safety net, changes in factor prices, and financial sector liberalization and reform. If China decides to appreciate only its currency, growth would slow and not much else would happen in the rest of the world. If China appreciates its currency and does all the other reforms, growth in the world is better and will hold up in China.
Questions and Answers
Q: The IMF has predicted that China will catch up with the United States in terms of GDP by 2016 on a PPP basis. When do you think the Chinese economy will catch up with the United States? Do you think it will happen before 2020?
On a PPP basis it is getting close. I think that around 2015 or 2016 is about right. We stop our projections at 2016 as we always only project five years ahead. It is important to remember that income per capita is still only 10% of the United States, and it will be much longer until it catches up on this point.
Already, China has become one of the most important players in the global economy. Looking at trade, it is the third largest exporter in the world. China is reliant on advanced economies for trade. A good portion of its financial assets are invested in the United States. The country is very integrated in the global economy.
You touched upon the idea that Asia and China are not immune from global shocks. You also mentioned that China could implement a positive policy response to mitigate the effects of shocks. Many are saying that, at this stage, due to massive financial expenditures in 2009 and 2010, China has accumulated financial burdens that will be reflected in its financial and government sectors. What is your opinion on this?
My view is that should there be another global shock, China should respond again aggressively, and that it has the means to do so. I believe it would be better to put more emphasis on measures that boost consumption over investment. It is easy in theory to spend more money on pensions, healthcare, and education, but it actually is not that simple.
When the IMF looks at China's public debt projections, we tend to be conservative. We assume a certain amount of non-performing loan (NPL) losses being taken over by the government. We have run debt sustainability analyses factoring in the large assumption of debt, and even so, public debt dynamics look good.
Q: I agree that it is obvious that there seems to be no correlation between money supply and inflation, but taking into account one or two quarter timeline factors, it could be argued that there is some relation between the two. I believe that the sharp increase in monetary supply from last year resulted in excess liquidity which went to real estate, foodstuffs, and other commodities. I would like to hear your views on this.
Looking at the literature produced by investment banks, you can find many arguing that there is a connection between money supply and inflation. The IMF did find that M2 had a statistically significant impact on non-food prices—but it was small. The biggest factor driving non-food, or core inflation, was shocks to food prices. The question is how much of the food price shocks are due to money supply growth, and how much are due to genuine supply shocks—econometrically, that is a really difficult question to get at for a variety of reasons. We just have not found a strong link between the money supply to non-food inflation. Looking at the rise in food price inflation, the cause is almost always pork prices. The question is open to debate, but we have not found the relationship you speak of in our work.
Q: Investments in housing and second houses in China remain limited, whereas in the United States there are indicators showing that the sale of housing is going up. It leads to the thinking that perhaps Chinese money has started to flow to the United States. It seems that in the Hong Kong market especially, the Chinese are investing their personal money in the rest of the world. Do you have any information about the magnitude of personal investment by the Chinese?
I can partly answer your question by showing you the outward foreign direct investment (FDI). It has really increased dramatically since 2004. Lately, it has been $50-60 billion a year. Nevertheless, net capital flows are still positive. The Chinese are investing more money abroad. As far as what is happening in Hong Kong, at least a year ago, there was the wide perception that Chinese money was driving the luxury real estate market. It is hard to say because Hong Kong has a very open capital account, and it is difficult to pinpoint from where the money in the real estate market was coming from. I would like to talk for a moment about the opening of capital accounts—would this be a good idea for the Chinese economy? For the global economy, it would provide demand. For the Chinese economy, my view is that it is the last step in a lengthy financial sector reform process. The country should really strengthen its domestic financial system first.
Q: My question concerns the possible negative impact on China from global shocks. As I recall, the main driver behind negative impacts in China from the global financial crisis was the existence of NPL in the country. Could you elaborate on the mechanics this will play in future global shocks?
For better or worse, China's financial system is not that integrated in the global financial system. We mostly see the transmission of shocks from advanced economies to China through trade. Demand in Europe and the United States slows, and Chinese exports slow, and as a result growth slows. Looking at the impact on China in the last crisis, it was really net exports that collapsed. Domestic stimulus keeps imports up, the fall in global demand causes exports to fall, and that hurts growth.
In the time of Zhu Rongji or Jiang Zemin, China took some radical measures to change its economic policy. By the time of Wen Jiabao and Hu Jintao, the country seemed to be taking more modest steps. Do you think that the next leaders will turn toward more radical policies to solve future issues? What are your expectations?
In the next couple of years there will be a change of leadership in China, and there is a lot of speculation going on about this. My advice is that, on several fronts, the pace of reform should be accelerated. There is always a risk when what you have been doing for so long has worked so well that you may become complacent. The adjustment process needed for rebalancing could have costs, including job losses. The tradables sector in particular would take a hit. However, there is a risk that if the country waits too long to pursue reform, it may have reform forced upon it in a less controlled manner. Particularly looking at growth in non-bank financing, if the sector grows larger than China's supervisory capabilities and if the capital account grows too open, financial sector reform may not be as orderly as China would like.
Q: Many people argue that in order to realize domestically led growth, China must establish a social welfare system. What are the prospects for this? Secondly, some argue that if China challenges the liberal economic regime, it will cause a serious problem for the world economy. How do you see this argument?
I will answer the second question first. One thing that the global community should do is make sure that China has a voice within international institutions. At the IMF, we have pushed to increase China's voice. We will hopefully be doubling its voting rights by next year, to around 6%. The second point is that we are all in this together. Increased reliance on the G20 is probably a good thing as China, India, and many other countries have seats at the table. The question is often raised of why China does not contribute more to international institutions, but I feel sympathetic given that its per capita GDP is one-tenth that of countries in Europe. The country cannot be blind to its domestic political concerns.
As for the social safety net, will reform help reduce savings in China? Yes. Particularly in healthcare—the more the government spends on health, the less people save. Part of the reason for low consumption in China is the underdeveloped social safety net. People are forced to self-insure, meaning they over-save. Healthcare now is almost universal, but the coverage is minimal and does not protect against catastrophic illness. Many reforms are needed. The challenge that China faces is to avoid the pitfalls of having an overly generous system relative to what society can finance. Whatever entitlements it creates, it needs to make sure it can pay for it. I think this will be very important for the rebalancing of the economy.
*This summary was compiled by RIETI Editorial staff.