In The Previous Crisis, China Built Roads To Nowhere; This Time, It Might Arrive

The Age

Tuesday October 28, 2008

John Garnaut

Beijing's leaders seem to be unaware of the scale of the global financial meltdown.

PRESIDENT of China Hu Jintao maintains that "the fundamentals of the Chinese economy have not changed". Let's hope that he doesn't believe it.

The last time Chinese export growth collapsed was during the Asian financial crisis, when former premier Zhu Rongji kept the engine running by printing money and building enough roads to stretch from Sydney to Melbourne and back again 100times. In three years Government spending rose from 16% of gross domestic product (GDP) to 24%.

Many of the roads went nowhere and the economy became seriously unbalanced, but Zhu saved China from recession and helped Australia ward off a similar fate.

A decade later, exports are twice as important to China, China is three times as important to global growth and the external shock has collided with the bust of modern China's first major domestic asset price boom. House prices are falling, the construction sector is comatose and heavy industry has been utterly flattened.

The good news is China has money to burn and its banks are recapitalised and relatively resilient. The bad news is Hu and Premier Wen Jiabao are either unaware of the scale of the threat to the real economy or too weak to deal with it.

So far the Government has cut property transaction taxes, reduced mortgage interest rates and promised to spend money in rural areas. But we are yet to see any of the fiscal resolve that saved the economy from a lesser threat a decade ago.

Here's a summary of China's policy predicament delivered by a well-regarded senior policy maker behind closed doors:

"Since the financial crisis hit China, the inflows of foreign capital have been reduced, so that we still have on the margin slightly net inflow, but not very much. But still we have ample liquidity.

"So, if the financial system is sound in terms of capital adequacy, corporate governance and risk management, then by and large the financial system is OK.

"However, the financial crisis mainly hit China through other channels, especially through the trade channel and the real economy.

"The GDP growth rate in China has slowed down significantly. Consumption is a bright point, at this point. Consumer price inflation will continue to decline in the last quarter of this year and we will see a pretty low number next year.

"The export outlook is not optimistic. A 1-percentage-point deceleration in Europe and US GDP growth leads to a 6-8 percentage point decline in Chinese export growth.

"Housing sales by square metre declined 15% this year so far (in the eight months to August compared with the same period last year) and this is a big sign of concern. We have to really look at it.

"The concern is about the future. People think that the unsold housing inventory has piled up and that is a negative for investors. And developers are really very tight in terms of money.

"This is a very controversial topic in China. A lot of people including economists are complaining that housing prices are too high and that a certain reduction is still good.

"On the other hand local governments reply that if housing prices decline then that is not very good. And so, right now the two opinions are really debating.

"From the central bank and ministry of finance, you can see the concern. The basic signal is that we have already eased a little bit. The best scenario is a soft landing, and you will see a small decline in housing prices but it won't be a dramatic decline.

"What is the policy response? Domestic demand, domestic demand, domestic demand. We are going to spend a lot of money on rural education and rural medicare and so forth.

And we are going to strengthen social security, enhance labour standards and strengthen the enforcement of environmental protection laws."

Housing turnover in most major cities is down more than 60% this month from a year ago and there is no sign of investors rediscovering their animal spirits or builders finding the money or the confidence to build. Goldman Sachs says the residential real estate market has to work through 22 months of supply. The heavy industries that supply the construction sector are on death row.

The scariest statistic to come out of the world economy last week was that China's rate of steel production in September had fallen by a fifth since June. The October figures will be much worse. Industry leaders say not a single steel mill or aluminium smelter is making money in China.

China's current leadership team has never faced a serious economic downturn and no Chinese legislator has ever had to handle a deflating asset bubble. Perhaps that's why they are still debating whether collapsing house prices at a time of extreme economic fragility might be a good thing.

They are anxious to get away from Zhu Rongji's investment-rich and services-poor legacy, for good reason. But building unwanted apartments and roads to nowhere is easy, while rebalancing the economy is not. China and the world are running out of time.

© 2008 The Age

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