China: Growth on track but at what cost?

This comes via Brown Brothers Harriman. I have highlighted the parts of particular note.

Macroeconomic Update:

The economy has slowed along with the rest of the world, as China has become much more dependent on trade as it integrates with the global economy.  However, growth is showing signs of picking up after China policy-makers used aggressive stimulus to boost the economy.  We expect GDP growth to decelerate to 8% from 9% in 2008 and 13% in 2007, but this is an improved outlook from earlier in the year, when many were looking for 6% growth this year.  China PMI remained above 50 in June for the fourth straight month, while Q2 GDP growth of 7.9% y/y was a noticeable improvement from 6.1% y/y in Q1.    

Monetary Policy Outlook:

The People’s Bank of China has already responded to the weaker growth outlook, cutting interest rates by 216 bp and commercial bank reserve requirements by 200 bp over the course of H2 08.  PBOC has been on hold in 2009 as fiscal stimulus moved to the forefront.  CPI fell 1.7% y/y in June, and was the fourth straight month of deflation.  However, exploding loan growth now has some analysts worrying about another asset bubble, which may prevent the central bank from easing monetary policy any further despite the risk of protracted deflation.  We believe further stimulus in China will be mostly on the fiscal side.


Social tensions will undoubtedly rise as the economy slows and slack in the labor market rises.  In addition, ethnic tensions in the western province also pose a serious risk to stability.  The good news is that China is clearly willing to use aggressive fiscal stimulus to give the economy a boost, and while some spending plans have already been announced, we would expect further measures if the economic outlook deteriorates.  As such, we believe that social tensions from economic hardship will not boil over into a destabilizing force in 2009 or 2010.  Aggressive fiscal stimulus can only be maintained for 2-3 years, though, at which time China needs the global economy to be back on track.  FDI may suffer if the Rio Tinto issue is not resolved transparently.

Currency Outlook:

China has signaled that the nominal yuan exchange rate is likely to remain steady for this year, as the policy of gradual appreciation has been put on hold since mid-2008.  12-month CNY NDFs are pricing in 1% nominal appreciation vs. the USD, but we look for modest appreciation to resume in H1 10 at a faster pace than this if the global economy heals as we expect next year.  We downplay any moves to globalize CNY or make it an invoicing currency for regional trade.  The lack of convertibility and the small size of the bond and FX markets in China will prevent any widespread globalization of the yuan for the coming decades.  There is a chance that CNY and HKD are somehow unified, but that too would most likely be decades away.

My read of this overview is that China will make its 8% growth target, an impressive feat given the economic climate. But, in my view, this is at the expense of a large bubble which seems to be inflating in shares and elsewhere in the Chinese economy.  The state-owned banks have been increasing loans at an unsustainable rate, suggesting that future loan losses will be high. See my comments in June posts “Chinese stock market bubble inflating” and “China’s present growth story is built on malinvestment.”

BBH also mentions that the Chinese managed float will not appreciate the renminbi over the near term.  That likely means a continued large albeit reduced outflow of capital from the United States to Asia.  If the U.S. economy continues to struggle, protectionist sentiment in the U.S. is likely to pick up under these circumstances.

This is an excerpt from BBH’s Asia Monthly Update for July 2009.  They have much more on India, South Korea, and Taiwan in the same piece.  As they are a very well-regarded research team, visit their site for more on this report and other research.  The URL is

  1. Vangel says

    China will import gold, silver, copper, potash, iron and other commodities that it can use now and in the future as a way to diversify reserves away from the USD, reduce its trade surplus and keep its currency from appreciating. Eventually, the government will have no chose but to allow the RMB to go up and when that happens the Chinese will find that they can afford to consume many of the products that they now export to the US. Contrary to popular opinion in the US, American consumption is not hard or all that critical for the global economy. When Americans realize that they are broke and can no longer bid for scarce resources consumers from developing countries will step up and take their place as goods become more affordable due to their rising currencies.

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