Dragon out of puff

They are relics from China's last economic slowdown in the mid to late 1990s, now scarcely noticed among the fresh crop of cranes as the province powers ahead with 15 per cent economic growth for the first quarter of this year.

Although China's economy officially grew at 7.8 per cent at the bottom of its last cycle in 1998, most economists now believe the true figure to have been more like 3 per cent.

The sound of screeching brakes in the run-up to the week-long May Day holiday yesterday revives the question: could it happen again?

China's demand for commodities will probably slow "quite significantly" as measures to curb investment bite more deeply, predicts China economist Yiping Huang of Citibank in Hong Kong.
That is short-to-medium-term bad news for countries such as Australia which supply China with raw materials, especially metals.

China is Australia's third biggest trading partner with $9 billion in merchandise exports going north each year. Exports have been growing at 8 per cent a year.

The growth has been concentrated in minerals and energy with agricultural exports actually falling in the 2003 financial year. In contrast, nickel exports to China grew 200 per cent in the same period.

"China has been the first and last topic at board meetings of Australian mining companies," Westpac senior international economist Huw McKay says.

The rollcall of new investments, floats and projects linked to China in the past year has been huge. BHP recently committed to another expansion of its Pilbara iron ore facilities to cope with demand and serial West Australian mining entrepreneur Andrew "Twiggy" Forrest has floated a new company, Fortescue Metals, on the basis of it. Never mind the rash of new nickel plays -- with resources that were only recently considered too difficult or too expensive to develop -- that have come to market.

Investment in the steel industry went up by 172.6 per cent in January and February this year, while in the same period cement investment went up 133 per cent.

"I don't think the kind of demand we saw last year is sustainable," says Dr Huang, echoing comments by People's Bank of China deputy governor Wu Xiaoling this week.

Extraordinary excitement over the Chinese "economic miracle" for the past year or so has created an illusion that China is on a one-way trajectory to economic heaven. But Dr Huang argues the Chinese economy is "not a one-directional story".

Not everything has headed skywards during the boom -- the agricultural sector, for example, has lagged way behind, while consumption remains a mere shadow of investment.

So even while it is officially committed to a two percentage point drop in GDP growth to 7 per cent this year, the Government will continue to shepherd investment into sectors where it sees a need: power generation, transport, agriculture, and the languishing western and northeastern provinces.

"I am sure the Government will step up measures to slow down investment but that doesn't mean the whole economy will slow sharply," says Dr Huang.

He forecasts 8.5 per cent growth this year (down from the actual 9.1 per cent growth last year) and 8.2 per cent next year.

The Government officially dumped the "growth for growth's sake" strategy, which has driven economic policy since the late 1970s, in March when Premier Wen Jiabao outlined a "putting people first" strategy for more balanced growth emphasising welfare, the environment and lifting up the 800 million people lagging behind in rural poverty.

But many, like China sceptic Joe Studwell, doubt the ability of communist China's economic engineers to differentiate between sectors with suifficient accuracy.

"Historical experience shows that communism doesn't do soft landings any more than subtle diplomacy, or get-to-know-you meetings with political dissidents," he wrote recently.

Economist Arthur Kroeber of China Economic Quarterly says a repeat of the 1998 slump to 3 per cent is now much less likely because the economy is more soundly based than it was then, when it was almost entirely state-owned and capital allocation was "just terrible".

"A lot of companies were making goods that would never be bought by any person at any time at any place for any reason."

Between 1990 and 1997, "on average, about 6 to 7 per cent of GDP every year was simply the increase in inventories," he relates. But in the five years since 1998, inventories have accounted for less than one per cent of GDP.

Not only are the types and qualities of goods produced now saleable, the people buying them are richer.

On top of that, the Government has intervened to curb growth at a much earlier stage in the cycle than in the 1990s when it allowed both inflation and GDP growth to reach well into double digits before acting.

Hu Shuli, China's best-known financial journalist, disagrees. She argued in a recent article that the failure to publicly acknowledge that China's economy was overheating last year was one of the reasons that tightening measures had limited effect, necessitating tougher measures now which have heightened the chances of a hard landing.

Even this week's moratorium on bank lending was supposed to have been done in secret, evident from the fact that once the news leaked, all the banks as well as the China Banking Regulatory Commission strenuously denied it.

This week's increase in the banks' cash reserve requirement by China's central bank was the third in seven months. Yet new lending by financial institutions grew a blistering 20.7 per cent in the first quarter, scarcely a blip below the rate of 21 per cent for last year, and still well above the target rate of 18 per cent for the whole year. Last year, fixed asset investment grew 43 per cent.

Earlier this week, the Government issued new rules meant to reduce the heat in the steel, cement, aluminium and property sectors. Companies must now put at least 40 per cent of their own capital into steel projects and 35 per cent for projects in the other three sectors, where previously they had to use only 25 per cent of their own capital.

Economists predict further tightening measures in the coming weeks, including new regulations on bank lending, more stringent lending rules in the four sectors targeted as overheating, and a 50 to 100 point hike in the lending rate.

Hong Liang, China economist for Goldman Sachs in Hong Kong, predicts a modest slow-down over the next two years rather than a hard landing, on the basis that underlying economic momentum remains robust and tightening is still confined to a few cyclical industries.

But a key problem is that the central bank is not allowed to form its own opinions on the economy and act as and when it sees fit, says the journalist Hu, calling for an urgent hike in the general interest rate which would "raise the cost of capital and highlight the difference between good quality investments and bad ones".

A general interest rate hike is a step the Government has been very reluctant to take for fear it is too blunt a tool, likely to harm the lagging sectors of the economy which it wants to promote.

Any general hike in interest rates would signal the Government was worried enough about overheating to abandon the levers by which it was seeking to fine-tune a sectoral economic slowdown and had been forced instead to risk the dreaded hard landing.