August 16, 2015 12:00 pm
Problems for China’s economy extend far beyond currency
Gabriel Wildau in Shanghai
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The sudden fall in China’s currency last week spurred a lively debate about whether the move was a victory for market reform or a competitive devaluation designed to shore up flagging exports.
But even those who believe the 3 per cent drop was aimed at exporters acknowledge that a weaker renminbi by itself is radically insufficient to cope with the challenges facing China’s economy.
“Currency depreciation to stimulate export growth is neither useful nor necessary,” said Qu Hongbin, HSBC chief China economist. He notes that while China’s exports have fallen this year, “exporters across Asia faced the same challenge, suggesting that the underlying problem is sluggish demand in developed markets”.
China’s economy officially grew at an annual rate of 7 per cent during the first half of this year, neatly in line with the government’s full-year target. However, some doubt that figure — Capital Economics, for example, reckons it is 5-6 per cent — and there are widespread suggestions that further stimulus will be needed to prevent a slowdown.
Yet an export revival would boost growth only marginally. Contrary to received wisdom, China has not pursued so-called “export-led growth” for the past decade. Net exports subtracted 3 per cent from annual growth in Chinese gross domestic product on average from 2004 to 2014. Meanwhile, investment contributed an average of 52 per cent of growth each year.
“China economic data for July may have lacked the lethal explosive force of last night’s detonation in the industrial city of Tianjin, but it laid bare the wider deterioration of domestic macroeconomic conditions,” Chen Long, China economist at Gavekal Dragonomics, a Beijing-based macroeconomic research firm, wrote last week.
Though property sales have begun to inch up following 13 consecutive months of decline, the market remains saddled with a huge overhang of unsold flats. That has caused developers to pull back on new construction, hitting demand for basic materials such as steel and cement. Faced with this slowdown, factories that produce these commodities are cutting back both on current output and investment in new capacity.
Even more distressing are signs that the production slowdown may finally be feeding through to the labour market.
China’s leaders are sensitive to the risk of social instability from a spike in idle workers, but they have so far been willing to tolerate four consecutive years of economic deceleration because unemployment remained low. That may now be changing.
China’s official unemployment rate is widely dismissed as unreliable, but an index of labour demand based on proprietary survey data from FT Confidential, a research service of the Financial Times, shows labour demand contracting in July for the first time since 2012. The index hit 49.3 last month, down from an average of 67.8 in the first six months. A reading below 50 indicates falling demand for workers.
Mr Li has repeatedly said China will not resort to heavy-handed stimulus that would boost short-term growth but exacerbate problems with excess debt and industrial overcapacity.
Instead, the leadership wants structural reforms to promote a new growth model that relies more on consumption and services.
So far the government has employed targeted stimulus in the form of fiscal spending on infrastructure, while resisting pressure to unleash a wave of lending from commercial banks to the manufacturing sector, as in 2008. That stimulus plan led to a quadrupling of China’s economy-wide debt from $7tn in 2007 to $28tn by mid-2014, equivalent to 282 per cent of GDP. B
ut if the job market continues to worsen, pressure for drastic measures will increase.
The wild card is deflation. Wholesale prices have fallen for 40 consecutive months, with the decline accelerating in July. Falling global commodity prices are largely to blame for Chinese deflation, but that is cold comfort for indebted companies whose nominal cash flows are in decline, even as the debt they owe remains fixed.
Tao Wang, chief China economist at UBS, said: “Clearly, the overwhelming problem for China remains one of rising deflationary pressures.”
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