Long game will work for country’seconomy

LAST month was a frantic time for global markets, with a largescale sell-off casting a dark cloud over emerging markets prospects. The US Federal Reserve’s (Fed) decision to keep rates unchanged last week puts the spotlight back on weak global growth.

However, a US survey of China’s economy, based on the Fed’s Beige Book, indicates that the Chinese economy is not nearly as weak as commonly believed, with services, which make up more than 50 percent of its gross domestic product (GDP), growing strongly and gaining momentum.

So looking beyond the current growth slump, what is the outlook for China’s economic landscape over the longer term?

China’s National Bureau of Statistics made headlines earlier this month with its less-than-compelling revision of its 2015 GDP growth forecast from 7.4 percent to 7.3 percent.

For China-watchers, who believe the actual rate is only 4 to 5 percent, the revision confirmed that Chinese economic data is notoriously unreliable, if not plain wrong.

To build a mosaic of the real state of the economy, analysts must survey a wide range of data, but a number of indicators like electricity output, rail traffic, vehicle sales and exports point to continuing weakness. Walking China’s streets on a recent trip, I noticed that signs of economic activity vary widely. For example, on the densely crowded, rushhour Beijing underground everybody has a cellphone.

Mostly younger generation, these commuters are messaging, watching video, playing games and shopping online. They barely look up between stations.

On the streets, JD.Com delivery scooters are everywhere, plying the streets with their distinctive maroon colours.

But across a large swathe of the industrial north, provinces like Gansu, Liaoning and Heilongjiang are coming in well below their growth targets and many plants are idle.

National rail freight volumes have slumped by 14 percent, the biggest decline in over 25 years of available data.

True, over the past few years China has followed a course of monetary tightening that would have laid many an economy low.

The real exchange rate has risen more than 30 percent since 2010, while bank credit has slowed sharply.

In the “shadow banking” sector credit growth has plummeted from more than 50 percent in 2010 to just 16 percent recently.

However, China needs to be viewed in both a shortand long-term context.

In the short term, it has announced a range of measures to turn economic momentum back up. This is not the big bang spend of 2009 when it pumped trillions into the economy, only to be left with a large bad debt headache. Spending is smaller scale and tailored to specific sectors. More lies ahead in the form of lower reserve requirements and interest rates along with some fiscal stimulus.

Recently there have actually been faint signs of acceleration in the housing market and money supply and credit growth.

Longer term, President Xi Jinping is in place until 2020 and controls all the main levers of power.

China has embarked on a wide range of reforms, with the focus on moving up the value chain and accelerating consumer spending and services. This does not mean that infrastructure will be neglected, far from it, as China’s capital stock is still low by developed country standards.

But the focus looking forward is on the services sector. The question is whether this “long game” can move China to rich country status. Can it fully unleash the innovative drivers necessary to make the transition?

There is a feeling that the state-owned banks and enterprises lack the creative flair and freedom to give China’s private sector room to leap forward as it must to achieve this goal.

It isworrying that China’s education spend is actually quite low, at below 2 percent of GDP. This is at odds with international test score comparisons where China does well.

But this may be testimony more to the ability to take tests by a motivated elite rather than a general level of education. Research and development spending per capita is also low.

The private sector is held back by a number of impediments. Notably, state-owned banks appear particularly cumbersome and interest rates for companies outside the state-owned sector are high. This is aggravated by deterioration in banks’ asset quality with exposure to ailing mining, manufacturing and provincial sectors, which have seen a steep dive in profitability.

Rapid urbanisation has been a feature of China’s growth path over the past generation. However, further gains are not assured. Many big cities have become unpleasant places to live and work for those pouring in from rural areas. China’s impact on the global economy is a magnitude greater than a decade ago. In 2001 its GDP made up only 7 percent of the world total and was about 35 percent of that of the US.

This year the comparisons are 17 percent and 105 percent, respectively. In short, while the US economy is recovering fairly well, it is no longer the “big gorilla” in the global economy.

China needs to come to the party too for the global recovery to retain momentum. From a South African viewpoint, the focus on China is through the lens of commodity prices, which have tanked in recent years as the key buyer has slowed down.

Some worry that the recent plunge in Chinese equity markets is a sign of a wider malaise in the economy. This is probably overblown.

The market had risen by 150 percent in quite a short time, boosted by a “close your eyes and buy” retail casino mentality on the back of margin credit. The subsequent correction has been poorly managed, but does not appear likely to pose a systemic risk to the economy.

My view is that the long game will work out for China. Despite demographic problems stemming from the one-child policy, over the next decade the huge population, massive urbanisation, economic reforms and infrastructure spend will gradually turn China into the world’s biggest consumer and services economy, with all the scale benefits that implies.

Graham Bell is a strategist at Old Mutual Equities, Old Mutual Investment Group.