China, not Europe, is 2012's great economic unknown

PUBLISHED : Tuesday, 10 January, 2012, 12:00am
UPDATED : Tuesday, 10 January, 2012, 12:00am


It's one of the great economic uncertainties of 2012.

I'm not talking here about whether the euro will still exist at the end of the year.

Yes, the European single currency will certainly survive, although it may do so without Greece and at the cost of intense economic pain among its other southern members.

No, the big unknown for 2012 is how Chinese growth will weather the softness of the big developed economies, and how policymakers in Beijing will respond if that growth should falter.

This uncertainty persists partly because Beijing is busy sending mixed signals.

Consider the property market; the destination of 25 per cent of China's investment, engine of much of its growth, and an important store of value for millions of investors.

For the past two years, in an effort to rein in surging prices and improve affordability, the authorities have tightened the credit available to buyers, and imposed sweeping restrictions on purchasers.

Today, some analysts say those control measures are working too well. Investors' expectations have taken a beating, sales volumes have collapsed, and now prices are following.

Anecdotes abound of developers slashing prices by 30 per cent or more, and offering cash rebates, even gold bricks, in their desperation to attract buyers.

But with confidence shattered and the developers running out of cash and sitting on big inventories of unsold flats, potential buyers are hanging back in anticipation of even greater price falls still to come.

Even so, the central government is maintaining its tough stance. With prices in many cities still higher than a year ago, Beijing has ordered local governments to keep their property market restrictions in place, and policymakers seem intent on steering prices lower still.

That could be a dangerous approach. Lower property prices mean less investment in the sector, less consumer spending by individual property owners, lower revenues from land sales for local governments, and rising levels of bad debt in the banking system.

On the other hand, there are clear signs that the authorities are now relaxing their tight monetary stance in response to easing inflation and a softening external environment.

At the end of November, Beijing cut the proportion of deposits banks are required to set aside as reserves. Last month, the banking system made a hefty 641 billion yuan (HK$783.5 billion) of new loans, up from a paltry 562 billion in November.

As a result, money supply growth accelerated, hitting an impressive month-on-month annualised rate of 26 per cent. More easing measures are expected over the coming months, led by further cuts to reserve requirements.

This easing is likely to continue, driven in part by political imperatives as the leadership transition at the end of the year approaches.

In the past, the government has always done its best to maintain strong growth in the run-up to leadership changes, while newly-appointed officials have typically stepped up investment the moment they take office in order to disburse economic rewards to their supporters. As a result, investment usually surges in transition years (see the chart above).

But while an investment surge now would boost headline growth figures, in the longer term it could do more harm than good.

Observers already fret that much of China's investment is being misallocated to wasteful vanity projects. Stepping up investment now would risk throwing good money after bad, weakening the financial system, and delaying reforms needed to wean the iconology off capital spending and to re-orient it more towards private consumption.

And as Diana Choyleva at Lombard Street Research points out, boosting investment now will drive up imports just as exports weaken, which could push China's current account into deficit. In effect, that means savings-rich China may be forced to borrow from the rest of the world to finance its growth.

'There will be no better proof of how excessive China's investment is and no better indication that the economy is about to hit a brick wall,' she warns.

Either way, the uncertainties surrounding the economy in 2012 are legion, and watching the evolution of policy promises to be as compelling in China this year as it was in Europe over 2011.