Is China's Recovery in Danger of Overheating?

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Macroeconomics

A report this week in the Shanghai Daily spoke vividly of the growth in the Chinese economy. While admitting the Chinese economy is still facing some problems, Li Xiaochao, a spokesman for the National Bureau of Statistics said rising industrial production, domestic spending and improved livelihoods (by which we take it he means increased domestic liquidity following greater funding of health care) has offset a slump in foreign sales (exports). Illustrating the effects of the stimulus package, the manufacturing sector grew 6.6% but services grew by 8.3% in the first half. Industrial growth generally accelerated in June to 10.7% on an annual basis. Encouraged by loose lending, retail sales grew by 15% in the first six months countering the slowdown in trade which decreased 23.5% through June.

As the only one of the top ten economies still expanding and with a stock market up 60% since the beginning of the year according to the Telegraph we could be excused for thinking everything in the garden is rosy. But we feel a word of caution may be in order. Since January, Chinese banks have issued 7.3 trillion yuan ($1,000bn) in new loans. Despite calls from the government to restrain new lending, banks doubled the amount they handed out between May and June. The amount being issued by banks now far exceeds the government’s 4 trillion yuan fiscal stimulus package and the volume of liquidity moving around the Chinese economy is worrying Beijing according to a separate Telegraph report. Meanwhile, M2, the broadest measure of money supply, surged at an unexpected record pace of 28.5% in June, up from the 25.7% increase in May. Moreover, China risks another property bubble, a risk local government in Hangzhou and Shanghai have already recognized by starting to scale back lending.

With meaningful growth unlikely to return in China’s export markets before 2010 and possibly beyond there is little prospect of China’s export business returning to the employment and growth levels seen in 2007/8. The current stimulus package will carry through into the second half of this year but then the authorities will be faced with the question, how much longer can China live on artificially generated internal demand? Transition to a consuming economy from an export driven economy will take years of structural change. Meanwhile impressive as China’s growth has been this year that resilience will be tested if export markets fail to make up for the inevitable tail off in stimulus activity later this year and next.

–Stuart Burns

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