PUNE - It's a month and a half since the Chinese
government announced measures to cool down its
overheated economy. The immediate reaction was that
application of brakes on a fast-chugging economy could
result in a monumental crash taking down everyone.
Investors were nervous. Global fund managers
were the quintessential hawks, watching every
development. Some were certain that the steps taken were
not hard enough, hence a direct market intervention in
the form of an interest rate hike and perhaps, a
devaluation of the yuan were necessary, though opinions
varied widely as to whether the Chinese currency would
be allowed to float or devalued.
Both of these
measures spelt disaster for corporates and investors in
the form of higher costs and lower margins and
profitability. Then, there was yet another segment of
China watchers, who felt that the steps taken were too
harsh. Instead of soft-landing the economy, the Middle
Kingdom would land hard on its back, with growth
decelerating from the current 9.5-10% per annum to 4-5%
instead of the more desirable 7-8% per annum.
A
month down the line, the fear of a "rogue" elephant
going berserk and taking down the rest of the world with
it have died down. In its place is the growing
realization that countries and investors across the
globe may now have to prepare themselves for a slower
China. This could mean reorganizing and reprioritizing
investment plans. It could also mean shifting and
reallocating investments slightly to spread the
risk-returns profile of investment portfolios - though
the question of where continues to dog everyone.
Neighboring India, which had held great promise
at the beginning of the year, is likely to stagnate at
least in the short run, because of the political
developments at home. But India is not alone. About
eight countries in Asia have already faced or are in the
process of facing their electorate. Most of them are
showing signs of wanting to re-order their economic
priorities post elections, particularly their approach
to foreign investments, market access and economic
open-door policy.
This is in a way good for
Asia. The status quo among the Asian countries
continues, with domestic compulsion not permitting
one-upmanship among the Asia-Pacific nations, thereby
not threatening the already fragile geopolitical balance
of the region. Yet a slower China means a slower Asia,
and a slower Asia does mean a deceleration in growth for
the rest of the world - unless revival in the
alternative growth poles such as Japan, the European
Union and the United States restores balance.
Interestingly, the irony of the situation in
Asia is that a slower China still means better
investment opportunities than elsewhere in the world. "I
think it [the measures] will only prove a hiccup, just
like the 1997 crisis in East Asia. China itself had a
major correction in the mid-1990s, and some years of
slow growth," Ashok V Desai, former economic adviser to
India's former finance minister, Dr Manmohan Singh (now
prime minister), and consultant editor for The
Telegraph, Calcutta, told Asia Times Online.
Why everyone loves China The main
reason for the world's romance with China in particular
and the Asia-Pacific region can be best explained by the
growth projections recently made by the London-based
Economic Intelligence Unit (EIU). It made the following
salient points:
The Asia-Pacific Region would continue to be the
fastest-growing region for the next five years.
The region would outpace growth rates in the rest of
the world.
China would continue to grow at under 8% annually
(though how much less is anybody's guess).
The region would see a 6.5% growth in 2004, though
this momentum would slow down in 2005 and onwards,
because of the "unfriendly" environment in the region.
The Asia-Pacific region would grow at a robust 5.8%
between 2004-08, excluding Japan.
Japan would grow around 4.4% in 2004 - its fastest
in 14 years - only to taper off to 2.1% in 2005 and 1.2%
in 2008.
The Association of Southeast Asian Nations (ASEAN)
countries would grow at around 4.9%.
The EIU
added its own word of caution to the projection.
"Concerns are mounting about the pace of investment and
credit growth in China. If, as seems likely, a bubble is
building, this could have significant repercussions, not
just for China itself but for the rest of the region."
It further said that though the bubble is not expected
to balloon out of control, but "nevertheless ... even
the gentle deflating of a bubble could be painful for
business".
Despite these words of caution, the
message is still loud and clear for investors. The
Asia-Pacific region continues to be the chosen
destination for investors. Further, a slower China is
still better than any of the fastest-growing economies
outside the region. Within Asia-Pacific, an over 5%
growth potential lies outside ASEAN (excluding
Singapore, Malaysia and Thailand, which are growing by
more than 5.9%) and Japan - which is very broadly China,
Taiwan, Hong Kong, Vietnam and India, with China still
at the top of the charts.
Having said that, the
issue arises as to what is considered the most desired
level of deceleration for the Chinese economy and to
what extent would such a slowdown impact its neighbors
and the rest of the world.
According to
Jean-Pierre Verbiest, director and assistant chief
economist at the Asian Development Bank (ADB), "The
current rate of GDP growth in China at about 9.5-10% is
clearly too high, mainly because investment growth is
surging at rates between 25 [and] 30%. The surge in
investment is putting enormous pressure on resources in
some sectors and is pushing up prices. These are clear
signs of overheating. However, what redeems the
situation is that the Chinese government has taken steps
to soft-land the economy and that the corrective
measures have been taken in time." The ADB, like the
World Bank, defines a soft landing for China at about a
7-8% annual rate of growth, while a deceleration
resulting in the Middle Kingdom growing at 4-5% per
annum is considered to be equivalent to the Chinese
economy landing hard on its back. "ADB believes a soft
landing is the most likely outcome of the policy
measures being taken. Compared to [another] period of
overheating (1994), authorities are also intervening
[very] early in the overheating episode," said Verbiest.
Economists are generally agreed - unlike
investors, whose views often find reflection in the
media as expert opinion from fund managers and
investment bankers - that a 7% annual rate of growth is
desirable and sustainable for China. At the same time
there is concern that even this level of deceleration
may impact growth in the region and the world.
Until China's accession to the World Trade
Organization (WTO), the biggest accusation against the
Middle Kingdom was that it was not integrated with the
rest of the world in terms of global trade and
investment flows. Since accession, China's integration
with the West and within the region has been so fast and
so broad-based that the very same reason is now being
cited as the cause for concern, in case there is a
meltdown of the kind seen in Mexico or Southeast Asia.
Global importance The importance of
China's economic health to the world economy can be best
understood if one understands the level of integration
of the Middle Kingdom into the global economy through
the value chain of transnational corporations. Very
broadly, China consumes anywhere between 20% and 50% of
the world's production of alumina, iron ore, zinc,
copper and stainless steel. About half is consumed at
home, while the rest is shipped out as value-added
exports to the West, particularly to the US and the EU.
Until now, the major beneficiaries of the
Chinese imports have been Japan, Taiwan and South Korea,
which in turn have been sourcing raw materials from
Southeast Asia, so much so that today China is Japan's
major export market, Japan's exports of capital goods
and transport equipment to the Middle Kingdom having
risen sharply. "This is a significant change, since the
US has been Japan's prime export market since the
1940s," Jonathan Story, professor of international
political economy with the Institut Europeen
d'Administration des Affaires (INSEAD) and author of
China: The Race to Market, told Asia Times
Online.
Hence, if you were to visualize the
world as a global economy, then you have multinational
corporations sourcing raw material in the poorer
Southeast Asian countries, which they shift to Japan,
Taiwan and South Korea, for some value-addition up the
production chain, before it is moved to China for
finishing. China continues to be a chosen destination
for multinational corporations (MNCs) for many reasons,
including cheap labor and skilled manpower. However, an
equally important reason is the fixed exchange rate and
the Chinese government's unwillingness to revalue its
currency against the dollar, though the latter has
depreciated sharply in recent times, giving Chinese
exports to the US an added advantage. These products
finished in China are sold as finished products in the
US and EU. Of course, this is a very simplistic
explanation of issues, but very broadly it explains how
deeply China and the Chinese economy have become
entrenched in the global value chain, which starts in
Asia and ends in the developed West. It is this link
that raises the potential for spreading sickness across
nations, if China were to go under.
The level of
integration that has taken place can be gauged by the
fact that China attracts US$450 billion in foreign
direct investments (FDI) every year, if one were to take
just the FDI flows into mainland China into
consideration. However, if one were to include Hong Kong
and Taiwan for purposes of calculation, the figure goes
up to $850 billion annually - no doubt egged on by an
overvalued yuan. According to Chinese Ministry of
Commerce data, the bulk of Chinese FDI comes from Hong
Kong, at about $373 billion per annum (giving rise to
allegations of round-tripping by Chinese nationals to
take advantage of tax benefits extend by the Middle
Kingdom to foreign investors).
US corporations
are a close second with $76 billion, followed by Taiwan
with $61.5 billion. Investors from Germany, France and
the Netherlands have direct investments in the range of
$14.3 billion, $7.2 billion and $9 billion respectively.
Canadian and British companies have sunk in $10 billion
and $19.6 billion, while Asia-Pacific rim neighbors
Japan, Singapore, South Korea and Malaysia have
exposures in the range of $49 billion, $40 billion,
$27.5 billion and $6 billion respectively. Naturally,
Hong Kong's Hang Seng Index reflects nervousness as the
Hong Kong administration watches every development,
since the Hong Kong dollar, and its financial system,
would be hit first by a flight of capital from China -
if that ever happens. As Story explains, China has
become the center of the Asia-Pacific economy. China's
trade deficits are with the countries of the
Asia-Pacific, and surpluses with the US and the EU. Over
the past year, China has accounted for about 50% of
world growth, so has therefore become a crucial market:
for growth, for manufacturing, for global consumption.
China's integration into this broad East-to-West
value chain is bad enough for spreading the contagion
effect in case of a meltdown, but experts have started
noting yet another trend. World Bank chief economist for
Asia-Pacific Homi Kharas recently told Asia Today that
he had noticed a new trend wherein the East Asian
countries were tending to import more components and
intermediate parts from China.
This is good
under normal circumstances, as the products of these
nations become competitive in the international market,
but this reverse integration could further mesh the
Asian economies so much that were China to go down or
slow down, it would leave its mark across the globe.
Asian alternatives It is in this
context that many Asia watchers have started to look at
India, Taiwan, Malaysia and Thailand. Global investment
bank Credit Suisse First Boston recently predicted that
India, Thailand and Malaysia would not be hit by a
Chinese slowdown. This is because their investment-goods
exports to China were less than 3% of the total exports,
as against say Taiwan, which has 27.8%, while Hong Kong
and South Korea have an exposure of 10% and 6.4% each.
In terms of growth, Malaysia is growing at about 5.9%
while India, Taiwan and Thailand are on a comparatively
high growth trajectory of about 6.9%, 6.0% and 7.7%
respectively. Thus if there is a shift of investments
and investor interest, it would be more on account of
their own domestic developments rather than because of
China.
"The new PRC [People's Republic of China]
leadership is attempting to ensure that the Chinese
economy diversifies into the 'knowledge' and 'services'
sector rather than remain confined to manufacturing,"
Professor M D Nalapat, director of the School of
Geopolitics at India's Manipal Academy of Higher
Education, told Asia Times Online. "The reforms the
Hu-Wen [President Hu Jintao and Premier Wen Jiabao] team
are putting in place are five years overdue, and should
ensure that the PRC continues on a steady upward rise in
total income. The confusion in India has helped the
process. The coming to power of the inexperienced Sonia
Gandhi, who depends for her survival on the communists,
may abort India's reform and upward trajectory to the
benefit of the PRC. India was emerging as an alternative
to the PRC for FDI."
Professor George T Haley of
the University of New Haven School of Business
elaborated that within Asia, there is a chance for some
countries to benefit through the reduced prices for
commodities, though there is a possibility that FDI into
China and India, and toward emerging Asia, might lessen.
There is also the strong possibility that the Chinese
will allow the yuan to float upward. "The overall
effect, however, is likely to be negative," he told
ATol.
Haley explained that this is because most
Asian countries have tied their economies to the big
Chinese and Indian growth engines, especially China's. A
slowdown in China would hurt the economies of virtually
all of East and Southeast Asia. Japan, growing more
dependent on China by the day, could suffer to the
extent that its recent economic rebound might be
derailed. "South Korea should do better than Japan, but
will still be hurt. Southeast Asia will be hurt, but
some countries stand a better chance than others -
Vietnam for instance," said Haley.
Experts are
hoping that any slowdown in China would be offset by
growth elsewhere in Asia including Japan, as well as in
the US and the EU. The broad expectation is that as
China increases its imports, especially from the United
States, it will ease the pressure to revalue its
currency, the yuan. The US is starting to see the impact
of a lower dollar translating into higher export
volumes, though it may take another 18 months for the
impact to be felt.
There is the expectation that
if Japan's recovery continues and Europe picks up,
demand for US goods and services would also increase.
Experts believe Japan's recovery looks sustainable,
given the across-the-board buoyancy in growth, though as
Kharas recently pointed out, the EU still looks
"slightly weak and more fragile".
Verbiest
clarifies that the ADB's Asian Development Outlook
assumptions are based on China's economy growing at
about 8% over the next two years. He points out that
there are two issues here. One, the slowdown in China
will be compensated in 2004 and to some extent in 2005
by faster growth in the US, in Japan and to a lesser
extent in Europe. These economies are large compared
with China. The US economy is, for instance, eight times
as large as that of China in current US dollar terms.
Second, a substantial part of the exports of Asia to
China are components for final-product exports from
China. "Strong demand in the US will continue to sustain
Chinese exports," said Verbiest.
Story added
that now that Japan is back on the path to high growth -
for the first time in over a decade - it will be
possible for it to make long-due market adjustments at
home. The US recovery is built on a fragile base. The
George W Bush administration's "dual deficits" arise
from budget allocations for homeland security and the
"war on terror". The US is turning to Japan and China to
finance its outlays in private and public consumption,
which makes its base fragile. Yet the US will continue
to have access to these funds for the time being. "As
long as financial-market reforms have not been
completely enacted in both Japan and China, investors
from both countries will continue to be attracted to the
high risk/high return capital markets of the US," said
Story.
Finally, there is the possibility of a
pick-up in Europe, led by three factors. These include
the continued growth in small economies such as Finland,
Ireland, the Netherlands and Sweden; the entry of the
Eastern European countries into the EU, providing a
major incentive for European-based firms to shift
production to low-unit-labor-cost countries; and the
economic correction within Germany. Story pointed out,
"Germany entered the euro 20% overvalued five years ago,
and may now have digested the overvaluation through much
higher-than-necessary unemployment. Yet I remain
pessimistic about the medium-term prospects of the EU,
because Germany, France and Italy still pursue
anti-market strategies."
Jayanthi Iyengar
is a senior business journalist from India who
writes on a range of subjects for several publications
in Asia, Britain and the United States. She may be
contacted at jayanthiiyengar1@hotmail.com.
(Copyright 2004 Asia Times Online, Ltd. All
rights reserved. Please contact content@atimes.com for
information on our sales and syndication policies.)
