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China's economic prospects 2/2011:The Chinese economy is challenged by a growing debt, real estate bubble and the stumbling Western economies; Finnish companies still optimistic

05.01.2012

During the last couple of years, the longstanding economic growth of China has culminated impressively as a rise to the largest industrial producer in the world, as well as the world’s second largest economy. The massive stimulus package helped China to live through the global economic crisis two years ago. Later, the Chinese decision-makers had to tighten the fiscal policy, in particular, to curb the overheating caused by the stimulus.

In 2011, the development of the Chinese domestic market has been characterized by the rise of food prices, expanding real estate bubble and the rapid increase in the wage level that has been spurred with noticeable rises of the minimum wages. The frantic growth in consumer prices seemed to fold in summer 2011, but inflation was still clearly above the target set by the Chinese government, and was more rapid in the countryside than in urban areas. The price of food supplies increased by over 12 %, partly due to the severe drought that afflicted many rice production areas in China. The expanding real estate bubble was shown in the violent, mostly speculative, rise of prices both in residential and business property. Towards the end of the year the weakened prospects started however to reflect also in the real estate prices, and several large Chinese real estate developers recently reported decreasing sales volumes. At the same time, the rapid growth of wages continued, which seems not been affected even by the global financial crisis. The long-term goal of the Chinese decision-makers is to increase the income level of the citizens, and the rises of the minimum wages have in many areas been around 15 %. According to the goals of the five year plan, the general wage level should rise about 40 % and the minimum wages by 100 %. At the same time, the government aims to foster private consumption by the reform of income taxation.

Besides the real estate bubble, the most significant threats to the Chinese economy are the rapidly increased debt in regional administrations, the financial difficulties of SMEs, as well as the challenges of the Chinese economic model behind these problems combined with the problems in China’s main export markets. As a part of the stimulus package, the central government obligated the regional administrations to invest e.g. in infrastructure projects, which has led them to run into growing debt. At the same time, the tax income of the state is decreased by the reform of the income taxation. As the debt of the state-owned companies is also increasing, the total debt of the Chinese state will according to some estimates rise as high as to 150 % of GDP. Because the Chinese economic model encourages banks to concentrate their lending to the large state-owned companies, small firms have been left to struggle alone with their financing. This has created a shadow banking sector operating beyond the reach of regulation that small and medium-sized companies need to turn to. The phenomenon has been especially observable in Wenzhou, a traditional model city of the Chinese economic growth, that has more recently become known as the center of speculation and shadow banking system.

Despite these local problems, the industrial production in China has still increased rapidly, albeit being slightly slower in the largest cities than elsewhere. Production expanded fastest e.g. in wood processing, machinery and electrical appliances, as well as IT industry. Finnish companies saw growth potential especially in the demand of special equipment for environmental technology. In contrast, the growth of textile industry clearly decelerated, which was based mainly on the record-high rise of the world market price of cotton by 170 % until spring 2011. Also retail trade increased rapidly, but for many products (foodstuffs, fuels, precious metals and jewelry), retail growth was based on the fast increase in prices. In comparison, the growth of car sales slowed down considerably.

China’s foreign trade continued to be buoyant after the rough slump in 2008. In January-September 2011, Chinese exports grew, especially, to some ASEAN countries, Brazil and Russia; at the same time, imports increased rapidly from Russia, Canada, Vietnam and Indonesia, in particular. One significant change was the decrease in the share of Japan due to the earthquake in March 2011, causing delivery problems to Japanese companies. The problems of the global economy seem to slow down the growth of demand in Europe and the United States that are important export markets for China. For example, Finland’s trade with China grew more slowly than Finland’s total trade. The largest commodity group in Finnish imports from China was telecommunications, radio and television equipment, the share of which however decreased considerably. Also Finnish exports to China increased more slowly than its total trade, as the deliveries of paper machines, among others, decreased. In contrast, the exports of fur increased rapidly, and the total share of pelt, skin and fur of the Finnish exports to China was already 8 %.

Inward foreign direct investments in China were still on a high level, and were manifold compared to the other BRIC countries. The inflow of FDI into China accelerated further in early 2011, and was growing as much as 30 % year-on-year. Also Finnish companies invested in China more than ever: the flow of Finnish investment to China was about 1.4 billion euro in 2010, which was no less than one third of all investment flows from Finland abroad. Thus China passed Sweden as the largest target country of Finnish investment, reflecting the positive expectations for long-term economic growth and the market potential in China. Several Finnish companies reported also about new investments or re-investment plans in China.

Among China analysts, there are various views about the future of the Chinese economy, and one can see the country to be at the crossroads of three paths. First, China may be on its way to become the world’s largest economy, which, however, would require many structural changes in its economy. The second possible path is the slowing down of economic growth and China’s future as a mid-income country similar to Mexico. The third and the most pessimistic scenario is the escalation of China’s current economic problems, such as the real estate bubble and the debt of regional governments, which, if spread out in the national economy, could collapse China’s current economic model. The future seems to depend both on the Chinese decision-makers and the development of the global economy. Some of the Finnish companies see also a potential in the possible downturn, “if one has war chest, to go to the battle field, and ride to victory.”

The complete report is available at:
http://cemat.aalto.fi/fi/electronic/prospects/china/

Further information: Director, Prof.Riitta Kosonen riitta.kosonen [at] aalto [dot] fi

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