Louis Kuijs's blog

Just as Asian economies started to recover from the global recession, policymakers and markets have started to worry about unwarranted asset price increases. While the worries are global, especially in the case of stock markets, the risks of asset prices bubbles seem particularly high in Asia, where abundant liquidity is driving up prices of all sorts of assets, from Hong Kong and Singapore real estate to Chinese art.

Where is the liquidity coming from? Capital inflows have received a lot of attention lately. Financial capital is flowing into Asia, attracted by the continent’s relatively good economic prospects. More important, for most economies, is a dramatic easing of domestic monetary conditions since late 2008 that has fueled domestic liquidity.

In part, the easing of monetary conditions in Asia was deliberate, a policy response to sharp weaker growth. However, some of the easing of monetary conditions was not deliberate. Economies with an exchange rate somewhat or completely fixed to the US dollar and fairly open capital markets are “importing” the loose US monetary policy. In some economies, those imported monetary conditions sit oddly with domestic economic conditions. In many Asian economies, spare capacity is much smaller than in the US and cyclical unemployment much lower.

The economic data for the third quarter of 2009, released almost two weeks ago, confirmed an impressive recovery in China’s economy, supported by very large fiscal and monetary stimulus. Real GDP growth rose to 8.9 percent year-on-year in the third quarter. This is clearly good news, for China and many other countries whose economies are benefiting at the moment from strong demand from China. As the World Bank economic team for China (which I'm part of) argues in more detail in the new China Quarterly Update, it also means that it is time to consider a less expansionary macroeconomic policy stance and focus more on the structural reforms needed to rebalance the economy and get more growth out of the domestic economy on a sustained basis.

It’s not as if China has not been hit by the global recession. China’s real economy has been hit hard. Exports fell sharply since November last year, and the contribution of net external trade to GDP growth was minus 3.6 percent points in the first three quarters of this year – with the negative contribution particularly large in the third quarter (in year-on-year terms).

As China’s economy seems to be recovering, many people here have expressed concerns about inflation. I was able to air my views on the subject in an Op-Ed in China’s main English language newspaper, the China Daily, together with two other experts.

In motivating their concerns on inflation, people cite the unprecedented fiscal and monetary stimulus in many countries to combat the global economic crisis, China’s own large-scale stimulus measures, or recent increases in prices of several food items as possible reasons. In my view we do not have to worry about inflation for now. There is simply too much spare capacity across the world. However, the very loose monetary conditions in China can cause other damage if left unchecked for too long. It makes sense to try to avoid future asset price bubbles and problems for banks’ balance sheets.

When China’s government started to work on and implement its massive stimulus program in November last year in light of a rapid deterioration of the world economy, economists working on China had to work out what it all meant for China’s growth, the composition of growth, and the rest of the world.

Many foreign observers doubted that the stimulus would be effective enough to boost domestic demand in the first place. But even among those with higher expectations in this regard—like we at the World Bank—many wondered what the stimulus would mean for the rest of the world.

Usually, when one country grows much faster than other countries, we expect imports into that country to rise much faster than exports (or, fall much less). However, in the case of China, exports had for quite some time been outgrowing imports by a large margin and many were skeptical that this would change even as economic conditions were changing in a pronounced way.

In a previous blog I summarized our views on China’s growth prospects, developed while writing the World Bank’s recent China Quarterly Update economic report. We think that China is likely to continue to see respectable growth in a difficult global environment. At this important juncture for China and the world economy, what is the upshot of this for policymaking?

At any point in time, governments need to work on short-term macroeconomic policies and on more medium- and long-term policies. There are trade-offs. More attention to short-term policies typically means less attention to the policies and reforms that are important for the medium and long term. We think that, given that China has already put in place a forceful short-term stimulus that seems effective in keeping growth respectable, China can put more emphasis on the structural reforms to promote continued, sustainable growth.

There continues to be a lot of discussion in China whether GDP growth will reach the government target of 8 percent this year, and whether the government should put in place more stimulus measures, typically presumed to be the kind of infrastructure-oriented stimulus that characterizes the package already in place.

I think it would not be a good idea to add more traditional, infrastructure-oriented fiscal stimulus in 2009. Why?

Getting a clear view on where China’s economy is heading is not easy at the moment, as evidenced by large variations in GDP growth forecasts. One of the confusing developments is that while exports have continued to do badly recently, the domestic economy has exceeded most observers’ expectations by a wide margin.

Working in recent weeks on the World Bank’s new China Quarterly Update, released today, we have been trying to determine how the economy has been doing on balance, what the prospects are, and what this means for economic policy. In this blog, I will summarize our understanding of recent developments and prospects, leaving the upshot for economic policies for a later discussion (keep reading after the jump).

A few days ago, our country director David Dollar blogged about the two-sided picture we see when we look at China's economic growth. The economy saw very weak export demand, which partly carried over into weak investment in manufacturing and other "market-based" sectors. Continued growth in other parts of the domestic economy was supported by policy stimulus.

China has weathered the crisis better than many other countries because it does not rely on external financing, its banks have been largely unscathed by the international financial turmoil, and it has the fiscal and macroeconomic space to implement forceful stimulus measures. China’s government has made use of this policy space by pursuing pretty forceful fiscal and monetary stimulus. From early November last year onwards, the government's 10-point plan ("RMB 4 trillion package") is being implemented. This plan emphasizes infrastructure and other investment, financed in part by government budget spending, and in part by bank lending. And the government has taken some additional, more consumption-oriented measures.

We cannot be too optimistic on China’s exports, even though we think the country’s competitiveness is still strong. Image credit: scobleizer at Flickr under a Creative Commons license.

As we were looking at recent developments as background for our China Quarterly Update, which was released yesterday, we had to make up our minds about how well China’s exports are doing. This was necessary because there are conflicting answers to this question. On the one hand, we are reading many reports from the coastal provinces, Guangdong in particular, about how bad things are there in the export industries, with factories closing and migrant workers going back to rural areas. On the other hand, the data on overall export developments suggests exports have held up reasonably well so far, with overall exports in real terms still far outgrowing overall world import growth, implying continued gains in global market share for China (see left hand figure below).

An important part of the answer lies in the fact that the export performance differs markedly between sectors. Exports of light manufacturing products, such as textiles and toys, are by now lower than a year ago in real terms (see right hand figure below), while real exports of (higher value added) machinery and equipment are still growing by over 30 percent year-on-year. Exports of light manufactures have been hit by cost increases as well as weak overall foreign demand—which matters a lot because China now produces the bulk of global production in certain sectors, such as toys. On the other hand, China’s exports of machinery and equipment still occupy modest market shares globally, and China’s strong underlying competitiveness means that its exporters can continue to gain market share even in more challenging global circumstances.

China's economy is slowing down. After years in which growth seemed only to go up, the pace of growth is moderating, affected by the global slowdown and tightening measures introduced since the fall of 2007 to contain inflation. Nonetheless, data for August on investment and exports surprised on the upside and on current projections the economy is on track to slow down to a still robust pace in line with short run potential growth of about 10 % in 2008. This is after 2 years with growth of almost 12 %, significantly higher than potential growth.

Given current weak global prospects, we project GDP growth to diminish further to around 9 % in 2009, even as China's domestic economy is holding up well. This provides some cooling of demand and price pressures that is helpful against a background of still lingering inflation concerns. Headline inflation has receded to below 5 % in August on the back of low food price inflation, but additional inflation pressure from higher energy and raw material prices is in the pipeline, and oil prices are still much higher than a year ago.

In our view, it would make sense to consider and discuss a stimulus package, although it still seems too early to implement a major package now. On current projections for the world economy--that is, with weak growth in the developed world, but still reasonable global growth--current developments in China do in our view not yet warrant a significant change in the macro policy stance.

The World Bank released the China Quarterly Update —of which I’m the lead author, full disclosure here-- today at a press launch in our Beijing office. The economic journalists noticed that the Bank’s projection for GDP growth in 2008 is now 9.8 percent, more than 2 percentage points lower than the outcome in 2007. Several journalists asked whether it is not time to stimulate growth by loosening macro economic policies and/or what would be the most appropriate policies to relax.

Somebody living in Dallas or Dusseldorf may find it difficult to understand why a government would want to stimulate the economy when growth falls to 9.8 percent.

The difference in perspective is related to a question that has been raised many times since the sub-prime problems broke out in the US: What will happen to growth in developing countries and emerging markets when the US economy, and the European one as well, slows down considerably? Many developing countries and emerging markets had been growing rapidly in the years preceding the sub-prime problems—much more rapidly than high income countries. But exports to high income countries are important for most of them. So the question was: can developing countries and emerging markets “decouple” from the high income countries?

The answer given by many economists was (as usual) yes and no. Developing countries and emerging markets that, like China, have successfully integrated into the world economy cannot decouple from the global economic cycle because a weaker world economy means lower exports and investment.