China has announced plans to pump nearly $600bn into its economy over the next two years, building new roads, railways, airports and low-cost housing. Could this be just the boost the world economy needs? Eoin Gleeson reports.
Why the excitement about this deal?
World markets rallied briefly earlier this week as China announced a plan to plough $586bn into its faltering economy over the next two years. Investors excitedly drew comparisons to Franklin Roosevelt’s New Deal in 1929, which many argue shored up the US economy after the Wall Street Crash. The hope of the bulls was that – having stood on the sidelines for much of the crisis so far – China, with nearly $2trn in foreign exchange reserves and a sovereign wealth fund with $200bn at its disposal, was moving to prop up the world economy just as it is keeling over.
So what is the plan?
China will do what it did when it battled the Asian crisis in 1998, and build its way out of the slump. Capital will be pumped into building new roads, railways, airports and low-cost housing. Beijing will also abolish credit ceilings for commercial banks to try to boost lending to small businesses, and cut VAT – a move that could save industry a further Rmb120bn, says The Economist. But the actual details of the building plan are sketchy, notes Jonathan Fenby in The Times, reflecting the fact no firm decisions have actually been made. What we do know is that less than half ($219.5bn) of the proposed budget amounts to fresh spending, says Bill Belchere, an economist at Macquarie Securities. Most of these building plans have been on the table for some time. The hope is that the announcement of the deal will stir up enough optimism at home to spur a spending spree by Chinese firms and households, says Mark Williams of Capital Economics, which will decrease China’s economic dependence on exports as global demand falls.
Has China just saved the world economy?
Absolutely not. China is just not powerful enough, says Lex in the FT. It still only accounts for 6% of world output. And a closer examination of its currency reserves, says John Chan on the World Socialist Web Site, reveals that between 60%-70% of its $2trn in reserves is already invested in dollar-denominated assets such as US Treasury bonds and government-backed corporations, mainly Fannie Mae and Freddie Mac. That leaves $600bn to $760bn left to lend. That pales in comparison to US public debt, which hit the $10trn mark at the end of September. And the West shouldn’t expect to see much of the $200bn that the CIC sovereign wealth fund is sitting on. Because every penny of that money will be needed to prop things up at home.
What’s the problem?
China’s economy is faltering badly. Exports, which make up 40% of GDP by some estimates, are sliding as US consumers close their wallets. Industrial production is at its lowest level in six years. Even if every cent of the $586bn in the new package is ploughed into the economy over the next two years, economic growth is likely to come in at 8%-9% for the next two years, according to Citi analysts. Not bad, you might say. But faced with an exodus of rural poor and a burgeoning young population, China needs to grow at 9%-10% a year just to stave off massive unemployment, reckons Nouriel Roubini on Global EconoMonitor. Factories are already firing workers daily. And with construction on the slide as well, investors are getting spooked. Glenn Maguire, chief Asia economist of Société Générale, told Bloomberg that $10- $20bn in “hot money” may have left China every month since July. When you consider that investment makes up 40%-50% of GDP, you begin to worry. “An avalanche of job losses is on the horizon,” says Chan.
Can China even afford this deal?
For now it can. The $586bn is about 15% of the country’s annual output. But China has a substantial trade surplus, and government, corporate and household debt levels look comfortable, so unlike Britain and the US, it has the money for a bout of public spending, as Cris Sholto Heaton points out in his MoneyWeek Asia email. Some of the spending will come from provincial governments, whose budgets are no longer swollen by sales of land at frothy prices and so may have to raise debt, says Lex. But assuming the increase was entirely funded by issuing debt, it would lift gross debt from 65% to 77% of GDP, says Williams – on par with the OECD average. But while it may be able to prop up its own economy, China can’t afford to bail out anyone else. The best that can happen is that the deal will bolster other Asian economies that have become dependent on exporting to China since the Asian crisis. Most don’t have strong enough domestic demand to survive a fall in exports, says David Roche in The Wall Street Journal. But if China does keep growth above 7%, there’s hope the coming downturns in Singapore or South Korea won’t be totally devastating.
Will the plan kickstart the commodities supercycle?
No. This isn’t like 1998. There is less scope for China to build this time around, says Capital Economics’ Mark Williams. And anyway, the reason the government is concentrating so heavily on construction is because that’s where the country’s problems lie. Sharp falls in Chinese demand for steel are the result of a big slump in real estate. And even if China manages to boost demand for building materials, like cement and steel, it won’t offset the global demand slump, Macquarie analyst Bill Belchere told Forbes. It took only a day for Australian firms Rio Tinto and Fortescue Metals to weigh up the impact of China’s ‘New Deal’. Their verdict? Time to slash iron ore output by 10%.