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China: Macroeconomic Cycles and Impact on World Economies Todd C. Lee Managing Director Asia Macroeconomics Group Global Insight Forum Atlanta Breakfast Seminar May 11, 2004 Copyright © 2004 Global Insight, Inc. China 2003 Report Card Macroeconomic Performance Real GDP rose 9.1% Industrial production up 12.6% Fixed investment up 26.7% Trade up 37.1%--exports 34.6%, imports 39.9% Microeconomic Impact Steel imports up 52% (world’s #1 steel importer); Consumed 33% of world finished steel Crude oil import up 31% (world’s #2 crude oil demand) Consumed 50% of world cement production Passenger car production rose 85% Copyright © 2004 Global Insight, Inc. 4/2004 2 Presentation Outline Why China is having such impact? Size, policy, and growth matter Supply side impact Demand side impact China’s impact is accentuated with each up-cycle Driving force behind China’s macro cycles Is this current cycle different? How will it end? Copyright © 2004 Global Insight, Inc. 4/2004 3 China’s Market Reform Marked by Openness to Trade Policy (Percent, share of nominal GDP) 40 30 20 10 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 Exports Imports Copyright © 2004 Global Insight, Inc. 4/2004 4 Tariff Reduction Already Substantial (Average tariffs, percent) 60 55.6 50 43.3 40 43.7 44.1 43.2 39.9 35.9 30 23.0 20 17.0 16.4 15.3 9.7 10 0 1982 1985 1988 1991 1992 1993 1994 1996 1997 2000 2001 2005 Copyright © 2004 Global Insight, Inc. 4/2004 5 Supply Side Impact Copyright © 2004 Global Insight, Inc. China’s Manufacturing Wage Competitiveness (Manufacturing wages, $ per hour, 2001) Japan United States Europe Singapore Korea Taiwan Mexico Brazil China Hi (Shanghai) China (National) United States: $16.14 China: $0.66 Shanghai: $1.26 0 2 4 6 8 10 12 14 16 18 Sources: U.S. Bureau of Labor Statistics, China’s National Bureau of Statistics China data are 2002 wage rates Copyright © 2004 Global Insight, Inc. 4/2004 7 China’s Human Capital Quality – Size Matters China U.S. Literacy Rate 86% 97% High School Graduates (aged 25+) 18% 84% (232 mil.)* (245 mil.)* 5% 26% (65 mil.)* (76 mil.)* 5.6 54.1 (7.2 mil.)* (15.8 mil.)* College Graduates (aged 25+) University Students (per 1,000 people) Source: Federal Reserve Bank of Dallas, Southwest Economy, Sept./Oct. 2003 * Absolute level Copyright © 2004 Global Insight, Inc. 4/2004 8 China Becomes FDI Magnet Due to WTO Entry (Percent of Japanese multi-national corp. finding country as favorable FDI destination) Rank 2000 Survey Ratio 2001 Survey Ratio 1 2 3 4 5 6 7 8 9 10 China U.S. Thailand Indonesia Malaysia Taiwan India Vietnam Korea Philippines 65 41 24 15 12 11 10 9 9 8 China U.S. Thailand Indonesia India Vietnam Taiwan Korea Malaysia Singapore 82 32 25 14 13 12 11 8 8 6 Source: United Nations Conference on Trade and Development (2002) Copyright © 2004 Global Insight, Inc. 4/2004 9 China Trade’s Sharp Rise after WTO Entry (Billions of U.S. dollars) 50 40 30 20 10 WTO Entry 0 1999 2000 2001 Imports 2002 2003 Exports Copyright © 2004 Global Insight, Inc. 4/2004 10 China Becomes Asia’s Export Platform after WTO (Monthly trade balance, billions of U.S. dollars) 8 6 4 2 0 -2 WTO Entry -4 -6 1999 2000 Japan 2001 Asia Excl. Japan 2002 United States Copyright © 2004 Global Insight, Inc. 2003 European Union 4/2004 11 Demand Side Impact Copyright © 2004 Global Insight, Inc. China Already a Major Import Market by 2002 (Billions of U.S. dollars) 11. China (domestic) 10. Netherlands 9. Belgium 8. Canada 7. Italy 6. China 5. France 4. Japan 3. UK 2. Germany 1. USA 173 295 0 200 400 600 Copyright © 2004 Global Insight, Inc. 800 1,000 1,200 4/2004 13 China Becoming A Dominant Import Market in 2003 (Billions of U.S. dollars) 10. Hong Kong 9. Belgium 8. Canada 7a. China (Domestic) 7. Italy 6. Japan 5. France 4. UK 3. China 2. Germany 1. USA 250 413 0 200 400 600 Copyright © 2004 Global Insight, Inc. 800 1,000 1,200 1,400 4/2004 14 China’s Macro Cycles since Reform Began (Percent change from a year earlier) 25 20 15 1984 Peak ? 1994 Plateau 1988 Peak 2004 Peak? 10 ? 5 ? ? 0 -5 1980 ? 1985 1990 Real GDP 1995 2000 2005 CPI Copyright © 2004 Global Insight, Inc. 4/2004 15 China’s Advancement with Each Cycle GDP Per Capita Imports Imports GDP (Bil. current $) (current $) (Bil. current $) (World rank) 1984 309 298 24 17 1988 401 364 55 11 1994 542 455 116 11 2003 1,564 1,203 413 3 Copyright © 2004 Global Insight, Inc. 4/2004 16 China’s Vigor/Chaos Cycles Copyright © 2004 Global Insight, Inc. China’s Current Cycle Tame Compared with Past (Percent change from a year earlier) 25 24.2 ? 19.1 20 15.3 15 ? 14.2 12.2 11.6 9.1 10 5 1.2 0 -5 1980 1985 1990 Real GDP 1995 2000 ? ? ? 2005 CPI Copyright © 2004 Global Insight, Inc. 4/2004 18 Causes of China’s Macroeconomic Cycles Gradualist reform creates mismatches between liberalized and non-liberalized parts of the economy Once government partially relaxes control, such mismatches would generate: Excessive growth and growth bottleneck – high growth not matched in efficiency advancement High inflation Strain on banking sector – mounting nonperforming loans Corruption Government then is forced to tighten credit and retrench liberalization Economic hard-landing ensues Copyright © 2004 Global Insight, Inc. 4/2004 19 Post Reform Vigor-Chaos Macro Cycles RETRENCHMENT STERILITY CHAOS LIBERALIZATION VIGOR Copyright © 2004 Global Insight, Inc. 4/2004 20 China’s Macro Cycles in Comparison Aggregate demand dominated by Possible cause Policy Response Landing retail sales fixed investment excessive investment, wage, and credit increases credit policy tightened interest rates increased soft, but short lived 1986-90 retail sales exports relaxation of financial policies in, public panic buying in response to admin price increases monetary and credit policy tightened investment reduced sharply price reform halted and partially reversed hard 1991-99 fixed investment retail sales exports investment push by central and local authorities monetary and credit policy tightened investment growth gradually lowered soft (IMF as of 1997). hard (by 1999) 2003-? fixed investment exports central government relaxation of credit expansion monetary and credit policy tightened admin crackdown on overheated sectors ??? Cycle 1982-86 Source: Oppers, Erik S. (1997), “Macroeconomic Cycles in China,” IMF Working Paper 97/135 . Copyright © 2004 Global Insight, Inc. 4/2004 21 What Drove The 2003 Cycle? (Percent change from a year earlier) 2000 Jan. GDP Exports Retail Sales State Investment Real 1 Yr Lending Rate (%) Money Supply (M2) Loans 2003 Dec. Sep. 02 8.0 27.9 9.7 9.2 5.50 6.05 9.1 34.6 9.4 28.2 4.60 4.35 6.01 16.1 16.3 2.11* 19.2 15.4 16.6 13.8 12.8 Dec. 03 19.6 19.6 13.4 14.2 21.1 * Hovered above 4% until October 2003. Copyright © 2004 Global Insight, Inc. 4/2004 22 Credit Growth Did Not Accelerate until Late 2002 (Monthly data, percent change a year earlier) 30 25 State Investment Stimulus Began Political Leadership Transition Began 12 10 20 8 15 6 10 4 5 2 0 1998 0 1999 2000 2001 Loan (Left Scale) 2002 2003 2004 Real Lending Rate (Right Scale) Real lending rate equals one year lending rate less CPI inflation. Copyright © 2004 Global Insight, Inc. 4/2004 23 But Why Is The Current Cycle So Tame? (Percent change from a year earlier) 25 24.2 ? 19.1 20 15.3 15 ? 14.2 12.2 11.6 9.1 10 5 1.2 0 -5 1980 1985 1990 Real GDP 1995 2000 ? ? ? 2005 CPI Copyright © 2004 Global Insight, Inc. 4/2004 24 But Why Is The Current Cycle So Tame? Mismatches between liberalized and non-liberalized parts of the economy have narrowed Domestic demand possesses structural weakness Inefficient SOEs’ need to restructure – Massive layoffs (or the prospect of which) depresses demand Structurally flawed financial intermediation – Non-state investment difficult to be funded through bank lending—non-state under-investment – Banks too scared to lend due to banking reforms – Impact of financial system problem just as serious as SOE problem, but less publicized and well understood Copyright © 2004 Global Insight, Inc. 4/2004 25 Coexistence of “Hot” and “Cold” in China (Percent change a year earlier) 25 20 15 10 5 0 -5 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Industrial Production Copyright © 2004 Global Insight, Inc. Jul-03 Jan-04 WPI 4/2004 26 Coexistence of “Hot” and “Cold” in China Part II (Percent change a year earlier) 60 50 40 30 20 10 0 -10 Jan-01 Jul-01 Jan-02 Exports Jul-02 Jan-03 Jul-03 Jan-04 Retail Sales Copyright © 2004 Global Insight, Inc. 4/2004 27 Saving Deposits’ Rapid Rise Reflects Weak Private Domestic Demand (Billion yuan) (Percent change a year earlier) 12,000 25 10,000 20 8,000 15 6,000 10 4,000 5 2,000 1998 0 1999 2000 Level (Left Scale) 2001 2002 2003 2004 Growth (Right Scale) Copyright © 2004 Global Insight, Inc. 4/2004 28 Short-term Macroeconomic Policy Dilemma Investment-led overheating Overheating in select sectors (e.g. steel, construction) Mounting bad loans (surging bank lending to SOEs) Corruption Persistent deflationary forces Excess-capacity, especially in labor (unemployment continues to climb) Private sector under-investment Weak consumer demand Mounting revaluation pressure on currency Growing trade surplus with US Surging foreign exchange reserves Hot money inflow Copyright © 2004 Global Insight, Inc. 4/2004 29 Beijing’s Policy Response and Effectiveness Government’s response so far Keep fixed exchange rate, while use other means to relieve revaluation pressure (ongoing) Used $45 billion of forex reserves to recap state banks (Dec. 03) Raising reserve requirement ratio by 1%, to 7% (Sep. 03) Admin crackdown on overheating sectors (late 03) Allowing central bank lending rate to float 0.63% above target (Mar. 04) Raising rrr by 0.5% on troubled banks (Mar. 04) Harsher admin crackdown on overheating sectors (late Apr. 04) Policies ineffective thus far Investment surged 43% in 2004 Q1 Industrial production up 18% Money and loan growth remained around 20% Copyright © 2004 Global Insight, Inc. 4/2004 30 How Will This Cycle End? Moderate policies so far because stability is key to the government No need for extreme measures yet because inflation is still tame Main concern is wasteful lending’s impact on the banking sector’s bad loan problem Likely additional measures: More admin crackdown Modest lending rate hike, but no deposit rate increase Plug holes from hot money inflow, keep fixed exchange rate policy If investment expansion does not slowdown in the next quarter, Beijing will adopt much harsher measures Soft-landing is still the baseline, due to tame inflation Hard-landing is possible, but unlikely: will happen if harsh crackdown coincides with a global recovery retrenchment Copyright © 2004 Global Insight, Inc. 4/2004 31