Bernardo M. Villegas
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Rebalancing Strategy
published: Mar 31, 2017

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China`s Slowdown and Philippine Growth (Part 1)

           Various economic sectors are worried that the ongoing slowdown of the Chinese economy may negatively impact on them.  Add to this dampener on global economic growth of the very low oil prices.  How will these global developments affect Philippine economic prospects as the Philippines moves to a new political era under the newly elected Administration that will be in place by June 30, 2016?

          First, let us understand what is happening to the Chinese economy. As explained by a top Spanish economist from the IESE Business School, Juan Jose Toribio, in the January 2016 International Economic Overview of IESE, the 2008-2009 global financial meltdown triggered a collapse in global demand and a considerable contraction in the exports on which China’s spectacular economic development had grown to depend. The reaction of the Chinese government was to focus instead on the construction of massive infrastructure and real estate projects, as well as maintaining, at all cost, the levels of investment of state-owned enterprises (SOEs).  All these were financed by massive flows of credit provided by both the official and shadow banking institutions. 

          Such massive pump priming led to capacity excesses at the SOEs and inflation ran rampant in certain real estate and financial assets.  The default rates of banks were concealed by the lack of transparency in much of Chinese economic data.  China financed the entirety of its economic boom with domestic savings, which were at an all-time high of 50 percent of GDP.  Since it did not depend on credit from abroad, this Asian giant had more time to deflate its double bubble and could let out the air in a more gradual and orderly fashion.  In the meantime, the Chinese authorities decided to reconfigure the economy towards growth in private internal consumption and a greater weight of the services sector, with substantial reductions in household credit. In what whatever way the Chinese government is able to achieve these aims, all indications point toward a contraction in the country’s growth, i.e. from the high of 8 to 10% during its heyday, to 4 to 6% in the coming years.  Because of its tight control of the economy, the Chinese government can manage a relatively soft and sustained landing, although a much more turbulent touchdown cannot be entirely ruled out.

          What could prevent a hard landing is the increasing strength of the middle class that can be the engine for a consumption-led growth.  David Murphy of CSLA, in a publication entitled “Keep Calm and Carry On,” estimates that the middle class in China numbers 374 million people (larger than the U.S. population).   These consumers remain optimistic about their financial future:  73% expect to be better off in three years’ time, only a slightly smaller share than in 2013.  Within the next five years, over half expect to live in a bigger home or drive a nicer car (about two-thirds picture themselves in an electric car or a hybrid).  An important reason for the resilience of the Chinese middle class can be found in the relative recovery in China’s housing market in 2015:   96% of the middle class own property and, on average, 56% of their wealth is in real estate.  An added reason for a more sanguine view of the future is the expectation that their leaders will avert a ruinous economic downturn.  In their eyes, Beijing has a well-established track record in this regard.

          Also boosting their confidence, in addition to the improving property market, are the high savings and low debt of the middle class.  Just 58% of them are in debt and only 8% are “extremely” or “very” concerned about it.  On average, their total outstanding mortgage debt equals less than two years’ annual family’s disposable income.  Their top concerns remain to be healthcare, education and retirement.  With low fertility rates and a rapidly ageing population, the Chinese middle class are increasingly focusing on quality in these services, reflected in high private insurance penetration, demand for property in good-school districts and a greater willingness to educate their children abroad.

          In contrast with this generally sanguine view of the Chinese economy is the view expressed by Martin Wolf of the Financial Times that the inability of the Chinese government to manage its high and rapidly rising corporate indebtedness might lead to a sudden halt in investment and a rapid depreciation of the renminbi.   There is a long-term issue of how to integrate China into the global financial system.  The opening up of China’s financial system to the world must be regarded as a matter of global concern.  A significant risk is the potential for a vast increase in two-way flows of portfolio capital, which are still modest from and to China.  Considering that China is the savings superpower, it is not hard to envisage a huge gross outflow due to portfolio diversification and capital flight, should controls be lifted.    It is highly probable that the impact of capital account liberalization would be a large net capital outflow from China, a weaker exchange rate and a bigger current account surplus.  We can only hope with Christine Legarde, managing director of the International Monetary Fund, that there will be collective action from all countries to effectively manage the immediate stresses in the Chinese economy and the longer-term challenges of China’s financial integration with the rest of the world.   (To be continued.)