China’s Economic Growth Comes With Risks

BEIJING (Dow Jones)–China’s economy has turned around with startling rapidity in recent months, with factory output, bank lending and commodity imports all accelerating on the back of the government’s massive stimulus program. The next challenge for authorities is sustaining that growth and keeping emerging problems at bay while weaning the world’s third-largest economy off of state funding. The sustainability of this state-driven growth spurt is a critical issue for the global economy. The success of China’s massive stimulus has been a rare bright spot in the worst global downturn in a generation, with all advanced economies expected to contract this year. A lot rides on Beijing’s ability to overcome a decline in exports, bolster its domestic economy, and avoid stirring a new bubble in the housing market. “China will be among the first countries to lead the global economy out of this recession,” said Hans Timmer, director of the World Bank’s economic forecasting department. Developing countries such as China are becoming a bigger driver of global growth as U.S. households cut back consumption and boost savings, he said. (This story and related background material will be available on The Wall Street Journal Web site, WSJ.com.) Economists estimate that China’s economy likely expanded by close to 8% from a year earlier in the second quarter, up from 6.1% in the first quarter. The official figure is scheduled to be announced early Thursday in Beijing. When measured in the same terms as other major economies - an annualized quarter-on-quarter comparison - China’s growth in the second quarter could be on the order of 15%, some private economists estimate. Even if the surge moderates in coming quarters, many analysts say China will very nearly meet its target of 8% growth for all of 2009. China has rebounded after authorities used the state-controlled banking system to engineer one of the most dramatic monetary expansions in history. Banks have issued twice as much in new loans so far this year as in the first half of 2008, and China’s money supply is now expanding at nearly triple the rate in the U.S. The credit boost has helped to restore confidence, and the activity it supports is, at least in the short term, good news for home builders, car makers and suppliers of commodities like copper. But the government’s strategy also carries risks. The flood of easy money into the economy could be spilling over into markets for stocks and real estate, and inflating fresh bubbles. Any buildup in bad loans and dud projects could weigh down growth and public finances. Also, the economy’s dependence on government-driven investment and credit mean that any policy hiccups could derail the pickup in confidence. “I do think there is a distinct and rising risk of an asset bubble and fluctuation in growth,” said Wang Tao, China economist for UBS. With so much activity crammed into the first half of the year, it gets harder to come up with more stimulus projects in the future, she said. Thus, it is more urgent for the government to devise ways to generate sustained growth in the private sector. “In addition to short-term stimulus, there needs to be medium-term thinking about changing the growth model,” Wang said. The government is already trying to fine-tune its stimulus to reduce the risk of bubbles. As U.S. housing prices slide, China’s are rising at a 10% annualized pace, fast enough for some to declare a new real-estate boom. The Shanghai stock market’s benchmark index has gained 75% this year, closing Wednesday at a 13-month high on some of the heaviest trading since 2007. The record surge in China’s official reserves of foreign currency, which hit $2.132 trillion in June, was driven partly by renewed inflows of capital from abroad chasing strong growth. Economists estimate such “hot money” totaled $30 billion to $50 billion in the second quarter. At the same time, China must take longer-term costs into account. As other countries are doing with their stimulus efforts, China is borrowing from future growth to support the economy today. But the implicit debt the authorities are taking on by supporting bank loans and local-government projects is several times larger than the official budget deficit of 3% of gross domestic product this year. That will leave it less ammunition to stimulate the economy again - even as it becomes clear that lending and investment can’t sustain their hectic pace. Officials recognize that government spending can’t drive the economy forever. “An improving trend in the economy does not mean that this difficult period is over,” Premier Wen Jiabao told a meeting of economists and businesspeople last week. China will continue stimulus policies while also undertaking structural reforms to support longer-term growth, he said. One reason why officials are reluctant to start phasing out the stimulus is weak demand for China’s exports, which are down 22% so far this year. Despite official concern about unemployment, the small businesses that account for most jobs remain starved for credit even amid the boom. The benefits of the stimulus program have so far been concentrated in the state sector, which employs only about 20% of the national work force. “The current recovery is mainly based on a short-term rebound in inventories, which is not the same as a trend recovery,” the State Information Center, an official think tank in Beijing, said in a report last week. “The material basis for an economic recovery would be the beginning of a new round of large-scale investment in capital equipment,” the analysts said, urging the government to do more to support private-sector investment. The best hope for a sustained investment boom may lie in China’s strong housing market this year. Although home sales collapsed for much of last year, confidence started to return after the stimulus plan was enacted. Residential property sales were up 50% in June alone. More importantly, developers have resumed building homes, encouraged by easy financing conditions and rising sales. The latest data show construction starts were up 12% from a year earlier in June, marking the first increase after 11 straight months of decline. Although slower than the 20%-to-30% gains of recent years, the improvement is welcome, because construction drives demand for steel and many other industries, such as home appliances. If demand from the housing sector can keep Chinese factories humming, they will in turn be able to invest in expansion, which would drive economic growth. Rich countries such as the U.S., Germany and Japan - which have been hit hard by the crisis - tend to specialize in making high-end capital equipment, and could benefit from a broader rebound in corporate investment in China. At the moment, however, China’s imports of capital goods are falling, and private-sector investment is trailing that by state enterprises. China’s purchases of metals and minerals such as copper and iron ore have soared this year, a trend that mainly benefits resource exporters such as Australia and Latin America. Even a housing boom would offer only partial support to China’s industrial base, with many export-focused factories still idle. The government is trying to fill the gap with subsidies for domestic purchases of cars and home appliances. Economists both inside and outside China are urging the government to look to local rather than foreign consumers for future markets, a suggestion that may be getting traction. “We will introduce innovative consumption policies … to unleash the potential of consumption in driving economic growth,” Vice Premier Li Keqiang said in a speech this month. On Wednesday, U.S. Commerce Secretary Gary Locke reiterated Washington’s argument that further liberalizing China’s markets and allowing its currency to appreciate would help boost consumption. “If China allowed for greater flexibility in its exchange rate and further opened up its domestic markets for imports and foreign direct investment, it would accelerate the world’s return to growth,” Locke said in Beijing during an address to the American Chamber of Commerce and U.S.-China Business Council.