Sri Lanka must watch the Chinese economy

Last week I met up with some key business people from Indonesia, which does heavy trading with China on the basis of subcontracted business, and is now attempting to diversify its business due to the volatility of the Chinese economy.

This made me conduct some research on the Chinese economy. The findings highlighted the need for Sri Lanka to be cautious but also need to be mindful of the enormous opportunity that exists for a small 60 billion dollar economy like Sri Lanka.

As it is today

The Chinese economy is likely to climb, from its current position, sixth, to the second largest by 2030. With Gross Domestic Product (GDP) growing at an annual rate of nine per cent, China is watched by the world in envy. But if one were to flesh out the numbers, the skeleton emerges.

But it is fair to say that the Chinese economy is out of control. Unbalanced, overheated and wobbling on the shaky foundation of a debt-ridden banking system and one can speculate that it is heading for a fall. This is not the first time that these sentiments have been heard.

Since 1978, pessimists have warned that the average annual growth rate of nine per cent was unsustainable and would end in collapse. So far they have been wrong but the indications are that the Chinese economy is getting there. Let me take the key indicators and the lessons the world can pick up.

China’s progress

The National Development and Reforms Commission, the pilot of China’s economy in its latest report, has said that fixed asset investment increased 29.8 per cent in the first six months of the year. In the automobile and textile sectors, the increase was more than 40 per cent, which is alarming.

The trigger for a crash could happen if there is a slack in demand in the US. The reason being, the main customer for low-priced goods from Chinese factories is the US. Exports and fixed investment account for more than 80% of China’s GDP, and any sudden fall in US demand would feed through into factory closures and higher unemployment in China.



The initial shock would, it is feared, be compounded by a financial crisis as it brought to light numbers of underperforming bank loans. In the short term, the Government would throw money at the problem by expanding public spending. In the longer term, the solution would be to expand consumption.

According to the Chinese Commerce Ministry, domestic supply exceeds demand for about 70 per cent of consumer goods. The gap is evident at many of the new shopping centres.



The best example cited by economist is the Beijing’s Golden Resources Mall, where the owners claimed it was the biggest in the world where the staff far outnumbers the customers.



After a launch period of two years, half of the restaurants have closed, so have the spa and beauty salon. Several chain stores have moved out too. The mall’s owners have abandoned a plan to open a car centre because prices have nosedived.

Some analysts say that China’s factories churn out two million more cars than the market demands. The learning to the world is that economic development must be managed with stronger credit management by the banks.

Too fast

It is true that China has not only maintained stable growth, but it is accelerating. Recent reports reveal that in one of its key sectors of growth, mobile phones, the country has already become the biggest telecom market in the world. Numbers have grown to more than 431 million, up 45 per cent over last year.



How fast is too fast? A recent survey among Chinese economists has revealed that 56 per cent say there are signs that the economy is overheating up from the 15 per cent from the last survey done.



Unless curbs on credit schemes and restrictions for land development by cutting down high energy industries are implemented, one cannot cool this shimmering economy. After much discussion, the interest rates have been changed thrice for the year but there are little signs of the economy cooling down. This kind of tinkering should have happened long before, as it takes time for the numbers to get reflected in the economic reports of the central banks of the world.

Balance

Another lesson from the Chinese economy is that it is growing more than twice as fast as Japan did during the bubble, heyday in the 1980s. To my mind Beijing’s problem is more one of balance than speed.



Developing countries tend to grow rapidly as they catch up with rich countries, especially a country with a huge population, which is extremely poor by global standards.



Considerable ground needs to be covered first to make up. This includes soft infrastructural issues like hygiene and sanitation so health standards are maintained with the booming economy – another lesson to the world. If not we will can see repercussions like the outburst of the Sars virus.

Unique China

China is unusual in many ways. It is the largest-ever developing country; it is the largest country to make the transition from a command economy to a market. It is also ageing fast, and lastly, it exports capital to the rest of the world rather than importing it.

In the recent past there have been distinct signs of over-investment and wasted resources on a colossal scale. It is important that one analyses the global trends vis-à-vis the local situation emerging. Recent reports from the IMF revels that 92 per cent of the foreign investment in 2006 has happened with acquisition and mergers, another point the world needs to note to avoid a waste of resources.

US experience

If we analyse the US economic development in the recent past, especially in the 19th century, it suffered periodic, painful and relatively short-lived boom-bust cycles as investors speculated wildly on often uneconomic projects.

China, it is feared, could be on the brink of something similar: a savage but temporary slowdown that will not affect the country’s long-term growth prospects.

Mismatch

There seems to be a mismatch between what the economy can produce and what it consumes, which has resulted in a big current account surplus and trade tensions with the EU over items such as bras, shoes and pullovers.

In June, China’s monthly trade surplus hit a record $ 14.5 b, putting the country on course to surpass last year’s record of $ 100 b annual trade surplus.

From the monies flowing in from all over the world, China overtook Japan this summer as the country with the world’s largest foreign exchange reserves. By the end of the year, its holdings are expected to pass $ 1 trillion.

This money flow can create a loose credit system that can result in more villa developments, shopping malls, steel mills and car plants. I believe the current policy of tightening lending policies can cool the economy and make it more manageable.

There are also complaints emerging that incentives and kickbacks are pushing development projects but the Central Government turns a blind eye to this area given the drive for stronger economic growth. I feel the unbalanced growth model has now become excessive.

The country needs urgent measures to arrive at more manageable growth. The longer it waits, the bumpier the correction will be – yet another lesson that the world can learn from China.



 (The writer can be contacted on [email protected].)