It seems China's economic outlook at last has stopped keeping investors up at night. For the last 18 months or so, experts have worried about China's prospects. Pointing to the economy's slow growth and its bursting real estate bubble, they have fretted over economic collapse, the possibility of a "hard landing," and the potential repercussions for the global economy and its financial markets.
Deeper analyses and real-world probabilities always suggested that such fears were overblown, but they have persisted nonetheless. Now recent data emerging from Beijing offers still more reason for investors to set aside their worst fears about China. Its economy, of course, will not recapture the astronomical growth rates of some years ago. But still, it looks quite capable of sustaining real growth in the range of 7.5% to 8.5% a year. Considering that this rate of expansion is more than four times the pace expected for the United States, it should provide considerable opportunity in Chinese investments, both directly and through equity purchases.
The slowdown in China, which has so frightened investors, has four rootsthree temporary, one more fundamental and none especially unmanageable. The first is the recession in Europe and subpar growth in the United States, both of which have slowed China's export machine, a major element in its overall growth profile. Second is the legacy of 2011's monetary restraint. Although reversed in 2012, effects of that restraint have lingered, as they always do. Third, the bursting of China's real estate bubble has constrained home building, previously a mainstay of Chinese economic growth. Fourth and more fundamental, China has made an explicit decision to use domestic development more in its growth strategy, probably a good move for the longer term but a cause of slower growth initially.
The less than stellar economic performance of Europe and the United States was bound to slow China's growth. After all, exports have accounted for more than two-thirds of that economy's overall expansion and the European Union is China's largest overseas customer, while the United States is its second largest. According to Chinese government statistics, overall Chinese exports as of November rose less than 3% from year-earlier levels, well down from expansions in the high teens averaged in 2010 and 2011.
Nor is there reason to expect much of an acceleration any time soon. Even with recent progress on Europe's debt crisis, the continent will take a long time to free itself from its financial and fiscal burdens and return to robust growth. At best, it will show very modest growth in 2013, and even that is in doubt. Nor does it look as though the United States will recapture rapid growth any time soon. But if there is no reason to look for much improvement on this front, there is also no reason to look for matters to get much worse.
If the export picture is still dim, things are improving on the policy front. In 2011, Beijing, fearing a rise in inflation toward 8% or more, ordered the People's Bank of China to drain liquidity from the Chinese financial system. It did so several times, by raising its benchmark interest rate and the percentage of reserves it required banks to hold against their loans and deposits.
While this behavior has left a mark on the pace of growth to date, now, with inflation back down to a much more acceptable 2% to 3% annual rate, the People's Bank has begun to reverse its policy stance. It has cut its benchmark interest rate and reduced the reserves required of banks.
Although it takes time for such a policy change to have its full effect, liquidity has already improved. According to People's Bank statistics, the broad M2 measure of money in circulation has risen a strong 14.1% above year-ago levels. Bank lending, too, has begun to recover and looks on track to reach 8.5 trillion yuan ($1.35 trillion) in 2012, some 13% over 2011 levels.
China's real estate problems also show some signs of improvement. Prices, of course, are down some 25% from their peak of a couple of years ago. Building activity has slowed accordingly. But if the sector hardly adds to growth, it would be a mistake to draw, as too many Westerners do, parallels between China's and America's real estate problems. With Chinese law insisting on 20% down on a first residence and 50% on a second, Chinese homeowners are much less leveraged than Americans were and are. China's debt lies largely with local governments, which, although hardly welcome, is a lot easier for Beijing to cope with than the widespread subprime debt was for Washington.
China can also look forward to a faster work down of excess housing inventories. Many Chinese have already begun to take advantage of now reduced mortgage rates, especially discounts of 15% for first-time homebuyers. But more fundamentally, there are 11 million marriages a year in China, and some 10 million to 12 million people a year migrate from the countryside into China's cities. Major cities already report increased transactions, and price erosion seems to have stopped. Chinese government statistics on home prices in 100 cities show an end to price erosion and even a modest rise for some months now.
The fourth consideration is both more fundamental and more complex. China is facing a difficult economic restructuring. Aside from the recent export slowdown, Beijing is well aware that it can neither sustain its past pace of export growth nor rely any more on exports as the economy's sole engine of growth. In the past 20 years, Chinese policy makers note, China's share of the global market has risen from a negligible number to some 12.5%.
Since the country cannot hope to redouble this gain, Beijing increasingly has turned to domestic development as a replacement for exports or rather as an additional engine of growth. China looks especially to enhance its consumer sector, which still amounts to only 40% of the economy (compared with 70% in the United States, for instance).
The expectation is that such an enhancement will balance the economy and buy domestic peace by allowing income and wealth to spread more thoroughly through the economy. Part of China's massive infrastructure spending aims to serve this need.
But there is no mistaking that domestic development naturally proceeds less rapidly than export-led growth. If the pace of expansion looks less impressive, the shift should strengthen the economy overall and leave it more stable, making the feared hard landing less likely, not more so.
Some who fear for China's economic future go deeper still and reference the country's difficult demographic reality. This is a matter of concern. Because the country has imposed a one-child policy on families for the last 30 years, the flow of new, young entrants to the work force has slowed and will continue to do so in coming years. This trend cannot help but hold back the pace of overall economic growth.
But, if there is legitimate reason for concern, it would be a mistake to read too much into this problem too soon. The legacy of what was an extremely youthful population still leaves China with a greater relative abundance of young workers than the United States, for instance, and certainly than Europe and Japan. China today still has almost nine people of working age for each person over 65 years old, compared with just over five for the United States and just under three for Japan. Even by 2020, according to United Nations estimates, China will still have almost six people of working age for each person over 65. The United States will have fewer than four and Japan will have barely two.
It is a developing economic constraint to be sure, and will in time become severe. Yet it has little place in an assessment of the next 12 to 18 months, or even the next five years.
Against such a backdrop, there can be little doubt that China will grow at a slowed pacenext year for cyclical reasons, and longer-term for structural and demographic reasons. But the hard-landing scenario looks increasingly remote.
Figures on manufacturing have already begun to pick up, as have measures of consumer spending. Many of the great multinationals operating in China, including General Motors and Caterpillar of the United States and Rio Tinto of Australia, have reported that China's firming economy warrants increased levels of investment. It looks as though China will meet the official expectation of 7.5% to 8.5% annualized real GDP growth over the coming 12 to 18 months.
The great potential for domestic development suggests that China can sustain growth in excess of 6.5% to 7% a year for a long time before demographic considerations come into play. While all these expectationsshort, intermediate, and longer termfall far short of past real growth rates of 10% to 12% a year, investors and business people need to keep in mind that this anticipated pace still exceeds that expected in the world's developed economies by a wide margin. Most definitely, China seems to be having a much softer landing than popular fears had suggested.
Milton Ezrati is senior economist and market strategist for Lord Abbett & Co.
and an affiliate of the Center for the Study of Human Capital at the State University
of New York at Buffalo. His most recent book, Thirty Tomorrows, linking demographics and globalization, will come out this year from Thomas Dunne Books of St. Martin's Press.
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