China’s Response to Global Turmoil
China should turn to fiscal stimuli, ease its monetary policy, and develop a long-term plan for the capital market in order to handle the financial crisis.
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Caijing Magazine
Frank Gong, Hong Kong-based chief China economist at JP Morgan Chase
9 October 2008
China should turn to fiscal stimuli, ease its monetary policy, and develop a long-term plan for the capital market in order to handle the financial crisis.
The world financial system came close to a meltdown in the past weeks, forcing the U.S. government to invest every effort in an attempt to pull it back from the precipice. The speed by which US policymakers moved is impressive and offers hope that the risks to the financial system may now be genuinely fading. However, some further damage has likely been inflicted on an already fragile economic landscape, which is shifting rapidly in the emerging economies, including China.
The response from China’s policy makers to the unprecedented events unfolding in global financial markets in the last week or so has been fast and decisive. In fact, in times of global turmoil, Chinese government officials have always been willing and able to enact strong countercyclical measures. A similar phenomenon is at work in the current cycle.
In recent months, policymakers have increased export tax rebates and eased lending restrictions to counter potential shortfalls in exports and investment spending. Last week marked an escalation of these efforts, beginning with the People’s Bank of China lowering reserve requirements for most Chinese banks by 100 base points and cutting the benchmark lending rate by 27 base points. Later in the week, actions targeted at the A-share market were announced, including a cut in stamp duty tax on stock transactions, direct stock purchases by China’s sovereign wealth fund, and buybacks of shares by government-controlled companies.
It is significant to note that this is the first time in China’s short history of stock markets that the state has offered to buy back shares of its own companies. The Chinese government has been selling and listing shares of state-owned companies in the market for the last 18 years. This move will help to balance out significantly the increased supply from the so called “unlocked” floatable shares left over from the none-tradable shares reform.
The fact that even in development financial markets there has to be direct and decisive government intervention in special times shows that the market is not perfect and cannot always solve all the problems by itself. The government’s “visible hands” sometimes have to be present. Indeed, while the U.S. Federal Reserve and Treasury appeared to draw the line on the use of public funds to support teetering financial institutions at the beginning, they ended with the unveiling of a sweeping plan that will entail a large injection of public funds into the financial system.
This kind of intervention is even more critical for China’s financial and capital market, which is still a long way from maturity. The government cannot simply stay on the sidelines where there is a financial panic and loss of confidence. Those who believe that China should not intervene in its capital markets at this stage are too idealistic.
Potential Slowdown Requires Additional Actions
With the world’s developed economies now tracking the slowest growth pace since the tech bubble burst in 2001, and with the latest financial market turmoil aggravating uncertainty about the global economic outlook, clouds have gathered over the outlook for China’s export sector, which is now equal to 37.5 percent of the GDP.
Slowing in external sector activity will in turn exert downward pressure on industrial activity and export-related private sector investment. Data show that some export industries, including textile and clothing producers, and even the tech sector, already slowed their investment growth in the first quarter of 2008. Domestic housing-related investment, which accounts for about a quarter of total fixed asset investment and has continued to expand rapidly so far this year, will also likely decelerate in coming quarters. Property transactions have slowed notably since late last year, but construction activity to date has continued growing strongly.
Investment Implications
With export slowing, industry output will slow; so too will private fixed asset investment. This means China’s demand growth for most industrial metals, base metals, and especially for energy and crude oil, will show significant slowdown. The above fiscal and monetary stimulus would only partly offset the externally caused slowdown. However, I expect all these measures will help to hold China’s GDP growth above 9 percent in 2009.
Rail road and infrastructure spending in particular would only mean the demand for cement and steel would outperform. But steel makers have a margin squeeze issue. Since they locked in iron ore price at the peak for a year, steel prices would still fall when overall commodities prices fall and consolidate. The only commodity that will still be good is cement.
Also when the export and industrial sectors are slowing down, job growth and income growth will slowdown. Construction jobs – say in building railroad and subways – are in general lower paying jobs. As such, in terms of consumption, staples will outperform discretionary. China’s auto sales growth, which has slowed down significantly to only single digit growth, is unlikely to recover much until late in 2009.
Last but not the least, I still expect China to push gasoline and diesel price reform and liberalization in the near term. Electricity prices will be hiked. Given China does not have to raise refined prices too much now to go for liberalization, there is more room for electricity prices to go up – given CPI inflation now is below 5 percent.