CHINA: A CONTROLLED SLOWDOWN

We have a very simple forecast for China: the red dragon will be fine for the next few years. In its attempt to correct financial excesses and to rely less on exports and state-directed investment for demand growth, China may well get into choppy waters for a while. But the rulers in Beijing have all the means they would need to overcome any such economic problems fast. With massive foreign exchange reserves of $3.5 trn and some capital controls, China is not vulnerable to a potential outflow of hot money if the going were to get rougher for a while. With a personal savings rate of around 50% and significant central control over financial flows, China could plug any funding gap in its official or shadow banking system easily and fast if it had to do so. With an inflation rate oscillating around 2.5%, China could reopen the credit taps and stimulate demand if it wanted to do so. The question is whether China wants to do so.

So far, China has chosen not to do so. China’s new leaders are reforming the country. In the process, they do not seem to mind some occasional financial tensions and a slippage in demand growth. Prime minister Li put it quite clearly in a speech in Guanxi three days ago. According to Reuters, he said that, as long as the “economic growth rate, employment and other indicators don’t slip below our lower limit and inflation doesn’t exceed our upper limit”, China “will focus on adjusting the structure and promoting reform”.

This seems to confirm our key point on China: If growth were to decelerate so much as to cause a rise in unemployment, the authorities would intervene. But as long as that is not the case, China will let growth slip. With the Chinese economy maturing and the flow of migrant workers from the rural hinterland to the cities slowing down, China needs less GDP growth to keep the labour market stable.

We do not know where the threshold is at which policy makers would intervene. But we are confident that they could intervene effectively whenever they chose to do so. Finance minister Lou Jiwei reportedly said in discussions in Washington yesterday that growth may be around 7% instead of the initial 7.5% target and that even a 6.5% rate would not be a “big problem”. Following such comments, we would not be surprised if the Q2 GDP number due on Monday were to come in below the 7.5% consensus after 7.7% in Q1.

These official comments fit the view that China is going through a deliberate and controlled slowdown, not a rout. If problems were to erupt, such as excessive financial tensions that could spread to the real economy or a rise in unemployment, China could easily open the credit tabs again and rekindle demand growth back to a pace that keeps the labour market stable.

As the Chinese economy matures, we have to get used to a less exceptional pace of demand growth there. In the transition to a new pattern of demand and to more reliable statistics, exports numbers can look weak. But even if China were to settle at a growth rate of, say, 7% soon, that would still be a lot of growth in one of the biggest markets in the world.

All in all, we see little need to worry very much about Chinese economy for the next few years. We do have serious long-term political concerns. The contrast between a growing and increasingly confident middle class and a one-party dictatorship becomes ever starker. At some point in time, China may feel major political tensions. But with the Chinese communists still delivering rising living standards at low inflation, a serious Chinese political crisis is probably still some years.