So, the Chinese economy does have a pulse after all.
Credit extension by banks and bond issuance by local governments are supporting some kind of revival in infrastructure investment, and a 30 per cent rise in the Chinese equity market since the start of this year is helping to lift the intensely pessimistic mood that paralysed Chinese spending in the latter part of 2018.
The stimulus policies that China started to introduce last summer, and intensified more recently, now seem to be reviving the patient.
From the rest of the world’s point of view, all this is greatly to be welcomed, since China’s last round of stimulus, which lasted from late 2015 until late 2017, did something amazing to the global economy. Thanks to China, commodity prices started to rise in early 2016 after more than four years of decline, and global trade growth started to pick up in the middle of 2016, following a disastrous period in which the growth rate of global trade had fallen below the growth rate of world gross domestic product. That stimulus delivered a substantial boost to the eurozone, helping to set the ground for a tightening of monetary policy by the European Central Bank, a process which in 2017 led to a substantial weakening of the dollar.
The dollar’s depreciation in 2017 encouraged a flow of capital to emerging economies which helped to support growth in those countries. This included China itself where, thanks to a large inflow of foreign funding that year, GDP growth actually accelerated for the first time since 2010.
So, the last round of Chinese stimulus created a kind of positive feedback loop: the stimulus helped to weaken the dollar which, in turn, helped to strengthen the Chinese economy, creating what economists ended up describing as “synchronised growth”.
The obvious question now is: what chance is there that today’s Chinese stimulus can recreate that positive feedback loop from which the world benefited so much a couple of years ago? The answer is not too encouraging, and there are two reasons why. The first has to do with China’s policy dilemma. And the second has to do with China’s shift towards a more consumption-based growth model.
China’s dilemma is this: it has GDP targets, and it has financial stability targets, but because of the credit-dependent nature of China’s growth model, it can’t reach those targets simultaneously. Increasing GDP implies rising indebtedness, which creates financial vulnerability; and increasing financial stability requires deleveraging, which threatens GDP.
This dilemma first became apparent to the Chinese somewhere around 2012 and, ever since, their response to it has been a series of policy flip-flops: sometimes growth is the priority, and sometimes financial stability is.
The problem is that as time evolves, China’s dilemma seems to have become more acute. In other words, raising GDP by a unit creates more of a threat to financial stability than used to be the case. And since China’s debt stock is now so large, any sacrifice of financial stability produces more nervousness in Beijing than in the past. This was perfectly summed up two years ago when Xi Jinping claimed in a speech that “financial security is an important part of national security”.
The growing acuteness of China’s dilemma has had two consequences which help explain where we are today. One is that China tends to flip-flop between its two targets more frequently, with the result that China’s policy cycles seem to be getting shorter and shorter. In very rough terms, a four-year stimulus cycle 2009-12 was followed by a three-year deleveraging cycle 2013-15, followed by a two-year stimulus cycle 2016-17, followed by a renewed focus on deleveraging in early 2018 that lasted only a few months.
The second consequence of the growing acuteness of China’s dilemma is that each time it flip-flops between its targets, it is likely to make that switch with less intensity than in the past. When your leader is telling you that you’re posing a risk to national security if you lend too much — a warning that Chairman Xi repeated two months ago — your willingness to take risks becomes a little muted.
And this is one reason why the world should expect less from the current round of Chinese stimulus.
A second reason is related to the fact that China is becoming an increasingly consumption-driven economy: the old investment and export led model is creaking, giving way to a greater reliance on the Chinese consumer. In the past five years, Chinese consumption has contributed more than 60 per cent of China’s GDP growth. A decade ago, that contribution was closer to 45 per cent. And China’s shift to consumption-led growth is being supported by this round of stimulus policies which, more than in the past, are designed not just to support investment spending like infrastructure, but consumer spending too.
The problem is that Chinese consumer spending is likely to deliver smaller positive spillovers to global commodity prices, to global trade, and to the eurozone than was true in the past.
All in all, then what we’ve got is the good news that China’s stimulus is becoming apparent; but the bad news is that its effects are unlikely to be as friendly to the rest of the world as they used to be.
David Lubin is head of emerging markets economics at Citi
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