China: Stimulus splits analysts

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By:
Lawrence White
Published on:

News that China’s National Development and Reform Commission is considering a new stimulus package in addition to the Rmb4 trillion ($586 billion) plan announced on November 9 will bring cheer to investors and analysts who regard the country’s growth as central to the prospects of an Asian, or indeed global, recovery from the present crisis.

The new plan, widely discussed in the Chinese media but not formally announced at the time of going to press, would focus on promoting domestic consumption rather than infrastructure development.

Details of this new plan, including the likely total to be spent, remain unclear but both this package and the previously announced infrastructure spending are being closely monitored because the health of the Chinese economy is seen as vital to the global battle against recession. Yiping Huan and Ken Peng, analysts at Citi, summarize this view in a note published on November 24. "The rationale for [the new stimulus package] seems clear – the policymakers hope to provide stronger support to consumption," they write. "Two weeks ago, the State Council announced a massive Rmb4 trillion fiscal stimulus package, concentrating on infrastructure development. That package should have a direct impact on growth performance. We believe it is necessary at a time when the global economy is falling rapidly. However, questions have been raised whether such policy action might exacerbate the overinvestment problem that policymakers have been worrying about. After all, the current government has been trying hard to rebalance the economy – slowing investment growth and stimulating consumer spending. Stronger consumption is widely seen as helpful for sustainable growth in China."

Huan and Peng conclude their summary by maintaining their above-8% growth forecasts for 2009 and 2010, and their peers tend to agree with them, with most investment banks near the consensus of around 8.5% GDP growth for China next year. That is the optimistic view but there are several reasons for caution.

"This announcement does not imply the government will
spend Rmb4 trillion of extra investments over the
next two years"

Yu Song, Goldman Sachs

The first is that the exact details of China’s spending are unknown. The plan was announced quickly after finance minister Xie Xuren was recalled to Beijing in the first week of November, and although the market was pleased at the speed with which the decision was taken and with the size of the package there is much debate as to how much of the Rmb4 trillion package can be regarded as new spending.

"While the announcement clearly signals a new phase of policy action in China," writes Yu Song, an analyst at Goldman Sachs, "we do think that considerable uncertainties over the ultimate size of the stimulus still remain despite the headlines that are being quoted in the press. Certainly, this announcement does not imply the government will spend Rmb4 trillion of extra investments over the next two years."

Song notes that much of the spending would have been made anyway, and that not all of it will come from the government. Song writes: "It has been reported that the Ministry of Finance has requested the State Council to allow local governments to issue debt. Such a move is in direct conflict with the Budget Law and the legislative change involved is likely to be a lengthy process."

Of course the public pronouncements of analysts at investment banks are only one part of the reaction to the Chinese spending plan, and some investors and bankers in Beijing are rather more pessimistic about the country’s prospects. Michael Pettis, a professor at Peking University’s Guanghua School of Management, is a self-described pessimist when it comes to China: "As recently as a year ago that was a lonely profession, but I seem to be having more company lately," he jokes – and he says that many market participants view the 8% growth target as a best-case scenario.

"One thing typical of developing countries with unstable balance sheets is that the balance sheet tends to reinforce trends," he says. "So, for example, the average estimate for US growth tends to be accurate, whereas that’s not so for somewhere like China."

Euromoney has spoken to investment bankers in Hong Kong who say, off the record, that they believe in China’s growth story but can see growth slowing to as low as 5% in the next couple of years if the stimulus package hampers growth. Although there is nothing to suggest they do not believe in their carefully researched predictions, analysts have an interest in keeping their estimates above 8% because China’s official targets call for that level of expansion and estimates below that level might then cause some degree of resentment in Beijing.

Pessimism

What is the pessimist’s case? Pettis says that he has heard of senior bankers proclaiming 8% growth for China in public, and offering lower estimates when asked informally.

"With monetary policy, you can never figure out the impact until you consider the automatic adjustment that will take place in response to any measure," he says. "So, for example, if you spend 60% of your GDP by taking money from banks you need a counterbalance; if you could just spend your way out of slow growth then the Soviet Union would have been the world’s biggest economy. Roosevelt didn’t simply announce the New Deal and then we were off to the races: it took six to eight years to have its full impact."

Pettis suggests that it will be important to watch announcements Beijing makes about the Chinese banks: one source of funding for growth would be to impose on the sector, by having the government sell debt to the banks. The policy would create new funds for government spending but could also be inflationary. "If it is not inflationary, then the credit contraction was much worse than we all thought," warns Pettis.

Whether the optimists or pessimists – those who predict 8% growth for China and those who expect 5% or 6% – turn out to be right will be crucial because Chinese growth and spending will be a key counterbalance to the US slowdown. Battered investment banks depend on China’s growth for much of their future revenues in Asia; countries such as Australia that export huge amounts of commodities to fuel China’s growth need it to keep spending. More details are needed on China’s spending plans and how they will help to maintain those crucial growth targets: much depends on them.