Stephen Roach (from Shanghai)
Once again, the world is hunkering down for the worst from China. Fears of a hard landing abound as the authorities attempt to cope with a seemingly explosive boom. In my view, those fears are overblown. Since the Asian crisis of 1997-98, China’s macro managers have defied the naysayers repeatedly. I suspect that a similar outcome is in the offing, as China once again succeeds in avoiding the pitfalls of the dreaded boom-bust syndrome.
Back in China for the second time in a month, I took advantage of the occasion to spend time with some old friends — seasoned veterans of the nation’s remarkable journey over the past several decades. They were on the inside of many of China’s more difficult moments over that period — from the Cultural Revolution and Tiananmen Square to the Asian crisis and SARS. They had seen it all. But several of them had also been on the firing line in 1993-94 — the last time an overheated Chinese economy flirted with the boom-bust cycle that most believe is once again at hand. In drawing inferences about what now lies ahead for the Chinese economy, they urged me to consider both the differences and similarities between the current situation and the circumstances of a decade ago. A synopsis of our discussions follows.
There are three key similarities between these two cyclical inflection points: First and foremost, there were major investment booms on both occasions. Annualized growth in investment in fixed assets peaked out at around 60% in 1993; in the first two months of 2004, the rate exceeded 50%. Moreover, in one important respect, the consequences of a Chinese investment boom are more serious today than was the case a decade ago: The investment share of GDP hit a record 43% in 2003, well in excess of the 34% share in 1994. Second, there was a leadership change in China on both occasions; Jiang Zemin became president in 1993, and the reins of power were passed to Hu Jintao in 2003. China has a long history of interplay between political and economic cycles, often using economic vigor as a foil to mask any frictions in a leadership change. Just as policies were predisposed toward accommodating the political cycle a decade ago, a similar bias could well be in evidence today. Third, liquidity creation went to excess in both periods, as measured by growth in the money supply as well as bank lending.
Notwithstanding these similarities, I was struck far more by the differences as seen through the eyes of China’s wise men. First, the overheating of a decade ago involved excesses of both investment and private consumption; today’s overheating is almost exclusively an investment boom — the consumption share of Chinese GDP fell to a record low of 54% in 2003. Second, while the investment boom of a decade ago was entirely state sponsored, this time it reflects the excesses of both public and private spending. Senior officials are inclined to believe that the current impetus is far more private — driven both by domestic enterprises as well as by foreign direct investment. To the extent that market-driven private spending is tied more explicitly to perceived returns than is the case for public investment, today’s excesses should be more benign. Third, while inflation picked up in both periods, the 22% annualized surge in 1994 dwarfs the 3% pace currently evident. Fourth, the fiscal situation was far more worrisome a decade ago than is the case today; back then, government revenues were basically stagnant, whereas today they are expanding at close to a 33% annual rate. Fifth, there has been a significant change in the culture of Chinese bank lending; ten years ago, there was literally no discipline to credit allocation, whereas today the focus on banking reform and the related cleanup of nonperforming bank loans has elevated the importance of credit quality considerations.
But the biggest difference of all between the China of today and the nation ten years ago is its character. The Chinese economy of 2004 is bigger, stronger, and far more experienced than it was in 1993-94 — far more capable of withstanding the stresses and strains of macro imbalances. China’s share of world GDP has basically doubled — rising from 2.1% in 1994 to 3.9% in 2003 (at market exchange rates). Its per capita income has pierced the US$1,000 threshold, long viewed as a critical milestone on the road to economic development. China’s exports have nearly quadrupled from US$120 billion in 1994 to $438 billion in 2003. Nor is China’s trade a one-way street. Its imports surged 40% in 2003, and China’s trade balance tipped into deficit in early 2004; its resulting demand for foreign-made components and products has turned China into an engine of growth for its major trading partners — not just in Asia (i.e., Japan, Korea, and Taiwan) but also in the United States and Europe (i.e., Germany). And China’s reservoir of official foreign exchange reserves has ballooned from $108 billion in early 1997 (the earliest data point) to $440 billion in March 2004.
But the wise men of China also urged me to give its macro managers credit for experience — that intangible characteristic of policy judgment that comes from coping with a history of macro management challenges. China is not your basic inexperienced, uninitiated developing country that suddenly finds itself on the Big Stage for the first time. Time and again, but especially over the past seven years, China has weathered tough learning experiences. It distinguished itself during the Asian crisis of 1997-98 — not only by resisting the pan-regional contagion of currency devaluation but by keeping the growth momentum of its real economy largely intact. A few years later, when the world entered a synchronous recession in 2001, an externally dependent Chinese economy barely flinched. “Proactive” fiscal policy measures were adroitly deployed to cushion the downward pressures from external demand.
I remain confident that China will pull it off again — bringing its large and rapidly growing economy in for a soft landing over the next couple of years. Unlike their counterparts in most major economies of the world, Chinese policy makers are frank and transparent when they see a problem of macro management that must be addressed. Notwithstanding the intense debate over China raging in many quarters of the world, I can assure you that inside of China, there is no such debate. From the Premier, to the State Council (the Chinese cabinet), to the central bank, there is unanimous agreement that forceful action needs to be taken to bring China’s lending-driven, investment-led, overheated economy under control. The People’s Bank of China has, in fact, tightened monetary three times in the past seven months in an effort to do just that. Like all central banks, it is mindful of the lags and will probably pause to assess whether the medicine is working. But if there is no slowdown in the months immediately ahead, I have little doubt that further tightening measures will be implemented. And I am equally confident that Chinese policy makers will keep acting until the economy flinches (see my March 24 Global Economic Forum dispatch, “China — Determined to Slow”).
Ironically, the legacy of a centrally controlled economy can have its benefits. This is one of those rare instances. The Chinese government has put out a marker with its downwardly revised 7% GDP growth target for 2004. With the official data revealing a 9.7% annualized surge in the first quarter of the year, the task becomes all the more formidable. But Chinese policy makers are well-practiced at the art of achieving targets and avoiding economic instability. As the economy evolves into more of a market-based system, it may well get tougher for the authorities to steer the big ship with great precision. But that’s not the case just yet. While China has taken enormous strides on the road to reform and transition, the government is still very much in charge.
The wise men of China have no doubt that the current leadership has learned the lessons of macro management well. They lived through China’s soft landing a decade ago, and are convinced that the authorities are perfectly capable of pulling it off again. I couldn’t agree more. If my personal experience over the past several years tells me one thing, it’s not to underestimate the capacity of modern China to rise to the occasion. My bet is on another soft landing later this year and well into 2005.