Global Snapshots n
2009-13 * July 2, 2009
Debunking Three Chinese Legends
In our last edition of Global Snapshots, we reiterated ourconfidence that the Chinese fiscal stimulus would work – atleast to boost short-term economic growth – and that weexpected domestic consumption to gain momentum in comingmonths. Still, we disagree with the conventional view on Chinawhich could be summarized – and, to some extent, caricatured – by a threefold misleading statement: (i) Chinese fiscalaccounts are so strong that fiscal costs of the stimulus arenegligible; (ii) the key problem in China is household savingswhich are too high, but are likely to be gradually rebalancedtowards more consumption; and finally, (iii) lower Chinesehousehold saving rates should help rebalance the Chineseeconomy and, more generally, the global economy. On thecontrary, we think that (i) the fiscal stimulus will have a muchgreater impact on the fiscal outlook than anticipated by mostanalysts; (ii) high Chinese savings are not driven byhouseholds, but by corporates – reforming the pension andhealthcare sectors might help, but will be insufficient; and (iii)there are still no signs that we are at the beginning of adomestic – and global – rebalancing of the growth pattern.
There is No Free Lunch: Fiscal Accounts Do Matter
Implementation of fiscal stimulus can be very efficient; but isnot free. From a relative perspective, China may have morefiscal firepower than both developed and emerging marketscountries. Still, the total cost of these gigantic fiscal measuresseems to be underestimated by most analysts. China’s officialfiscal deficit projection is around 3% of GDP for 2009(excluding social security and extra-budgetary funds). Evenafter assuming that expenditures could moderate in the secondhalf of the year, a budget deficit of 4 to 5 percent of GDP lookslike a more realistic scenario. Although Chinese authorities canhandle a higher than expected deficit in 2009, there is no fiscalfree lunch; and a higher deficit in 2009 means there will belower fiscal ammunition for 2010. Thus, even though weunderstand the reasons behind greater optimism among mostmarket participants for 2009 GDP growth, which we longargued were excessively pessimistic, we find it difficult tounderstand the rationale behind a significant upward revisionfor 2010 based on expectations for continued acceleration ofpublic investment.A breakdown of the fiscal stimulus spending should revealsome skeletons in the public debt closet; and could forceChinese authorities to acknowledge that public debt ratios,including various levels of government, are actually muchhigher than official data currently show – i.e., potentially farabove 45% of GDP, rather than below 20%. Sub-nationalgovernments in China are responsible for a much larger shareof spending than in most other countries. Local governmentshave not been legally allowed to borrow, although thisconstraint has long been bypassed and only sporadicallyacknowledged. Not only will local governments have toconcede how much debt they have on their balance sheets,but the central government will also have to come up with amore consistent legal framework for local governments to havedirect access to the debt market. Since the start of this yearthe central government has been operating a pilot programwhereby the MOF will issue bonds on behalf of localgovernments, but we are still very far from an independent andefficient framework for sub-sovereign debt in China.
Savings and Consumption: Getting the Debate Right
Yes, Chinese saving rates are high and consumption is not thekey driver of the economy. Nevertheless, retail sales continueto be fairly resilient and appear likely to accelerate. Wereiterate that the most interesting stories coming out of Chinawill come from consumption, not from investment. Still, we arequite skeptical that reforming pension and healthcare hold themagic key to unlocking the consumption potential of China.
Contrary to common perception, households were not thekey contributor to the rise in saving rates. It was corporateand government savings that drove savings rates higher.The well-known Chinese savings glut is primarily acorporate phenomenon, not a household one. Whilepension reforms and healthcare reforms may help toboost domestic consumption in the future, the key issue tomonitor at present is clearly on the corporate side.
Moreover, on the household front, consumption didn’tstagnate but investment soared. While retail sales andreal consumption saw robust growth over the last coupleof years (on average by 9% on a real basis), investmentgrowth outpaced them both. Consumption lived in theshadow of investment and consumption’s share of GDPhad to decline.
Overall, saving rates seem to be only partially driven byprecautionary savings in the absence of poor pension andhealthcare systems. Income distribution and risingincome disparities may have played a much bigger role inexplaining why Chinese savings rates are high.
No End in Sight for Imbalances
There is no obvious quick fix. Certainly, education, pensionand healthcare system reforms might help, but this will be farfrom sufficient. It would also require a significant change inincome distribution and investment structure. With such arecent aggressive fiscal stimulus and still rising current accountsurpluses, China does not seem to be heading in this direction.In the short term, surpluses and rising supply capacity willcontinue to dominate. We are, therefore, both constructive onChinese consumption
skeptical that Chinese growth modelwill evolve in the near term.