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chapter 1

2 Political Outlook
Economic Outlook

SWOT Analysis

China is the fastest-growing major economy in the world, and this has lifted hundreds of millions
of people out of poverty over the past generation.
China has a massive trade surplus, and its US$1.9trn of forex reserves serve as a major cushion
against external shocks.
China’s economic policy-makers are committed to continuing their gradual reform of the economy.

China’s economy has been growing too fast for its own good. This has led to major imbalances,
and environmental degradation.
China’s dependency on exports to boost growth has made it vulnerable to the global recession.
Private consumption remains weak, at less than 40% of GDP.
The close relations between provincial leaders and local businesses are fostering corruption, and
are making it harder for the central government to enforce its policies.

China’s economic growth is slowly becoming more broad based, with domestic consumption likely
to rise in importance vis-a-vis exports, thanks to a middle class of 200mn-300mn people.
China’s ongoing urbanisation will be a major driver of growth, and new cities will emerge in the
less-developed inland provinces. The UN forecasts China’s urban population rising from 40% in
2005 to 73% in 2050, a gain of 500mn people.
As China moves up the value chain, it will develop its own global brand name companies, fostering
innovation and growth.

There are fears that the global recession of 2008-10 will mean an end to China’s double-digit
growth rate.
Despite a halt to the appreciation of the yuan currency, the recession is leading to job losses in
China’s export sector, and thus increasing social instability.
Relatively high food price inflation could become structural, as farmland is lost to industry or pol-
lution, and farmers migrate to cities.

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CHINA Q2 2009

BMI Economic Risk Ratings

The Chinese government has decided to train one million unemployed university gradu-
ates over the next three years in addition to providing loans to companies who hire them.
According to Chinese news agency Xinhua, the government will provide loans of up
to CNY2mn (US$292,400) to labour-intensive companies who recruit graduates, and
will provide a grant of CNY50,000 (US$7310) to graduates who want to start their own
companies. However, with an estimated 6.1mn college students expected to graduate in
2009, the government’s efforts are unlikely to be enough at a time when unemployment
is continuing to rise.

S-T Economy Rank Trend

China 93.5 1 =
Hong Kong 82.9 2 =
Taiwan 81.3 3 =
Thailand 74.8 4 =
Malaysia 73.8 5 -
South Korea 71.9 6 =
New Zealand 70.6 7 =
Philippines 68.1 8 =
Indonesia 64.4 9 =
Japan 63.8 10 =
Australia 63.1 11 =
India 62.5 12 -
Bangladesh 54.2 13 =
Cambodia 54.0 14 =
Vietnam 48.3 15 -
Pakistan 43.8 16 =
Sri Lanka 37.3 17 =
Singapore - 18 -
Laos - 19 =
North Korea - 20 =
Myanmar - 21 =
Regional average 63.0 Global average 62.4 Emerging Markets average 59.8

L-T Economy Rank Trend

Taiwan 77.9 1 =
Malaysia 75.7 2 =
Hong Kong 75.2 3 =
South Korea 73.9 4 +
China 71.6 5 =
Australia 71.1 6 =
New Zealand 68.0 7 =
Thailand 67.9 8 =
Japan 65.9 9 =
Indonesia 62.1 10 =
India 61.8 11 -
Vietnam 57.8 12 +
Philippines 55.4 13 =
Bangladesh 53.8 14 =
Sri Lanka 50.5 15 =
Cambodia 49.3 16 =
Pakistan 45.0 17 -
Singapore - 18 -
Laos - 19 =
North Korea - 20 =
Myanmar - 21 =
Regional average 63.0 Global average 62.4 Emerging Markets average 59.8

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Economic Activity
Q408 GDP Data Confirm Our Fears BMI View
As anticipated, Q408 GDP data confirmed that China is far from immune from the unfolding Economic growth dipped to a seven-year low
global recession, with real growth dropping to 6.8% y-o-y. This marked the weakest out- of 6.8% in Q408, dragging full-year growth for
turn in seven years and dragged full-year growth to 9.0%, a sharp decline from the 13.0% 2008 to 9.0% – a sharp decline from the 13.0%
recorded in 2007 and the first time since 2002 that the world’s third largest economy had recorded in 2007 and the first time since 2002
failed to register double-digit headline growth. With things expected to get worse before that the world’s third-largest economy had
they get better, we are anticipating further grim news from China in H109, and reiterate failed to register double-digit headline growth.
our below-consensus 5.6% growth forecast for the year. However, the bad news does not stop there.
Recent macroeconomic data has shown that
Indeed, trade data for December revealed that both imports and exports suffered a second economic activity continues to cool, and we do
consecutive month of contraction, with exports falling by 2.8% y-o-y, accelerating from not foresee any turnaround in fortunes for the
the 2.2% decline recorded in November, while imports plummeted by 21.3% y-o-y having Chinese economy until the second half of 2009
dropped by 17.9% in the previous month. Notably, Exports to the US (which purchased at the very least, highlighting that is more likely
17.7% of China’s total exports in 2008) fell by 4.1% y-o-y in December to compound to be 2010 before a recovery gets under way.
November’s 6.1% decline, while shipments to the EU (which, with a 20.5% share, was With this in mind, we expect real GDP growth
China’s single biggest export destination in 2008) fell 3.5% y-o-y in December after re- to slow to 5.6% in 2009.
maining flat in the previous month.

We have recently revised down our 2009 growth forecasts for both the US and the EU – from
-2.0% and -1.6% to -2.3% and -2.5%, respectively – implying that export growth is likely to
remain in negative territory (or at least remain very weak) over the near term. Meanwhile,
imports are likely to follow suit as commodity prices continue to trend lower, demand for
inputs for manufacturing exports decline and domestic demand remains sluggish.

Worst Outturn In Seven Years

Domestic Demand Unlikely To Come To The Rescue Real GDP (chg % y-o-y)
To be sure, although not as bleak as recent trade data, leading indicators of domestic 14
demand are painting an increasingly bearish picture. Retail sales grew by 19.0% y-o-y in 11
December, and although this is still a strong number, it nevertheless marked a third con- 9
secutive month of slower growth having reached 23.2% in September 2008. Meanwhile, 6
urban fixed asset investment (FAI) growth slowed to 26.1% in 2008. Once again, while 4
this is still an impressive outturn, December nonetheless represented a third straight month 1
of slower growth after peaking at 27.6% in the January-September period. Moreover, real

estate investment continued its rapid slide in December, with growth decelerating for a Souce: National Bureau of Statistics

sixth month in a row to 20.9% y-o-y, having hit a record high of 33.5% in June.

Property price growth dipped into negative territory in December, and leading property
market indicators suggest that the slowdown has further to run. The quantity of land pur-
chased – an indicator for future property development – fell by 5.6% y-o-y in November,
according to the most recent data available from the National Statistics Bureau, compounding
the previous month’s 2.6% decline, while growth of floorspace of commercial buildings
sold spent a ninth straight month in negative territory after it contracted by 16.5% y-o-y in
November. Perhaps most worryingly though is the fact that despite growth of floorspace of
commercial buildings under construction continues to slow (it registered growth of 18.7%
y-o-y in November, down from a peak of 32.1% in February 2008), it is still expanding.

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CHINA Q2 2009

This means that the gap between supply and demand is rising at a rapid rate, implying that
property prices will remain subject to strong downward pressure throughout H109. Given
Downturn Has Further To Run that real estate investment accounts for approximately 20% of all urban FAI, and that FAI
Property Sector Leading Indicators (Top) and Prices
(Bottom), % chg y-o-y in turn accounts for more than 40% of GDP, this bodes very ill for headline growth.


Furthermore, with investment in manufacturing contributing an even bigger slice to urban

FAI than real estate, there seems little reason to hold out hope that FAI growth in 2009
can maintain anywhere near the 20%+ levels witnessed during China’s recent boom pe-

riod in 2009. Although industrial output growth rebounded slightly in December from the
Floorspace Of Commercial Buildings Under Construction
Land Area Purchased
Floorspace Of Commercial Buildings Sold
record low of 5.4% y-o-y registered in November, it still remained lacklustre at just 5.7%.








To put this in context, full-year average industrial output growth in 2007 was 18.0%, and
was 16.1% in H108, and official sources have been quoted as saying that factory output
All Property
New Homes 12
Existing Homes
needs to grow at at least 12% if the government is to meet the 8% growth target which is

6 widely seen as the minimum required to ensure sufficient job creation. Meanwhile, year-
to-date growth in secondary industry slowed to 9.3% in Q408, according to the National

0 Bureau of Statistics, marking a sixth straight quarter of decelerating growth after peaking
at 13.7% in Q207.







Source: National Bureau of Statistics, National Development

and reform Commission

Can The Government Save The Day?

In view of the increasingly dismal outlook for the Chinese economy, we are expect-
ing further aggressive monetary easing and fiscal stimulus to be rolled out as Beijing
tries to avoid a doomsday scenario. Indeed, given that producer price inflation dipped
into negative territory on a y-o-y basis in December, contracting by 1.1%, and that
consumer price inflation – which slowed to just 1.2% y-o-y in the same month – is
Consumer Price Growth To Follow
Producer Prices Into Negative Territory likely to follow suit in Q109, the People’s Bank of China (PBoC) certainly has scope
Consumer & Producer Price Inflation (%) to slash interest rates.
Consumer Price Inflation
Producer Price Inflation

8 However, given the lagged effects of any such moves, and the immediacy of China’s
problems, we fear that they will not have the desired effect. Indeed, with approximately

CNY3.1trn of China’s mammoth CNY4trn (US$585bn) fiscal stimulus package ear-
0 marked to be spent on infrastructure projects in their various guises, it seems difficult
to see how Beijing will be able to successfully front-load its additional spending given

the length of time required to put construction projects into action. Thus, although we’re
Source: National Bureau of Statistics
not saying that government initiatives will have no effect, we maintain our 5.6% growth
forecast for 2009.


2005 2006 2007 2008e 2009f 2010f 2011f 2012f 2013f
Nominal GDP, CNYbn [1] 18869.2 22164.8 24973.5 26844.5 28634.6 30518.2 32859.8 35415.2 38063.8
Nominal GDP, US$bn [1] 2303.60 2780.90 3285.00 3864.90 4170.50 4522.30 5095.90 5712.90 6344.80
Real GDP growth, % change y-o-y [1] 10.4 11.9 13.0 9.0 5.6 6.8 7.9 7.6 7.6
GDP per capita, US$ [1] 1762 2116 2459 2870 3072 3305 3696 4111 4531
Population, mn [1] 1307.60 1314.50 1336.10 1346.80 1357.50 1368.20 1378.90 1389.60 1400.30
Industrial production index, % y-o-y, ave [1] 16.3 16.4 18.0 12.9 6.9 9.0 11.1 10.6 10.1
Unemployment, % of labour force, eop [2] 4.2 4.1 4.0 4.2 4.8 4.4 4.4 4.3 4.2
Notes: e BMI estimates. f BMI forecasts. Sources: 1  National Bureau of Statistics, BMI. 2  National Bureau of Statistics.

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Beijing’s Nightmare Coming True

Our concerns appear to be increasingly echoed by government officials, with Liu Mingkang,
chairman of the China Banking Regulatory Commission, describing the task of meeting
the official 8% growth target as ‘exceptionally arduous’, and central bank governor Zhou
Xiaochuan also admitting that downside risks exist. Moreover, the State Information Centre
Grim Prospects For Employment
(SIC), a government think tank, has said the FAI may decelerate in 2009 despite Beijing’s Purchasing Managers’ Index Employment Sub-Index

ambitious spending plans. According to the SIC, the government funded only 3.88% of 56

FAI projects in 2008, with 77.43% financed by companies’ own funds and the rest by bank 54


loans and foreign investors. Amid the current global economic climate, Chinese and for- 50

eign companies alike are very unlikely to be able to increase capital spending to the extent 48


required. The SIC has said that while local governments were eager to start new projects, 44

most planned investments would stay on the drawing board without corporate support. 42














More worryingly, however, are previous comments made by Liu which suggested that Source: National Bureau of Statistics
growth below 7% could trigger social unrest. We are now already at this point, and with
mounting anecdotal evidence and official data highlighting the rapidly weakening of the
country’s job market, social unrest is worryingly close to becoming a reality. Indeed, an
estimated 10 million migrant workers have reportedly already lost their jobs, while the
latest purchasing managers’ index revealed that employment prospects weakened further
in December with the employment sub-index falling to 43.3 from 44.3 in November.
While many other governments will be facing similar pressures, the lack of any outlet for
citizen dissatisfaction in communist-ruled China makes the current situation a particularly
volatile situation.

Fiscal Policy
Fiscal Shortfall To Widen Sharply In 2009 BMI View
Having recorded a surplus of CNY1.2trn in the first eleven months of 2008, China’s China’s fiscal balance swung sharply into deficit
full-year budget balance plunged into the red in December as the combined spending of in December 2008 as Beijing ramped up spend-
central and local governments climbed by 30.8% y-o-y to CNY1.66trn (US$243bn). With ing in the final weeks of the year in an attempt
revenues lagging way behind at CNY325bn (a meagre 3.3% increase over the equivalent to counter the ongoing economic slowdown.
year-ago period), a CNY111bn full-year deficit was recorded, reversing the CNY154bn With economic activity forecast to slow further
surplus registered in 2007. in 2009, China’s fiscal shortfall is expected to
widen from the 0.4% of GDP estimated for
While this was equivalent to a still very manageable 0.4% of GDP, it nonetheless represents 2008 to 2.6% in 2009, as the government tries
a sharp reversal in fiscal policy direction. Since reaching a multi-year high of 2.6% of GDP to spend its way out of the current crisis. Mean-
in 2002, China’s fiscal deficit had narrowed in each of the following four years, and actu- while, with such a heavy focus on infrastructure
ally reverted into surplus for the first time in over 18 years in 2007. Thus, the 2008 budget spending, we continue to question the efficacy
figure signifies an end to fiscal consolidation and the dawning of a far more aggressive of the government’s CNY4trn (US$585bn) fiscal
approach to fiscal policy. Indeed, December’s data underscores Beijing’s intent to throw stimulus package.
all its available resources at propping up rapidly sagging growth, and with this in mind,
we expect to witness a sharp widening of China’s budget deficit in 2009.

China has already announced a CNY4trn fiscal stimulus package aimed at boosting eco-
nomic activity over the next two years, and Prime Minister Wen Jiabao was quoted in

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CHINA Q2 2009

the Financial Times as recently as February 1 saying that Beijing ‘may take further new,
timely and decisive measures’. Indeed, with real GDP growth slowing to a seven-year low
of 6.8% y-o-y in Q408, and 20 million migrant workers having lost their jobs, according
to Chen Xiwen, the director of the Office of the Central Rural Work Leading Group, it
appears that further fiscal stimulus is very much on the cards.

At the same time, the Chinese government must contend with slowing revenue collections.
Among a number of moves to ease the tax burdens on its citizens, Beijing has cut income
and stock-trading taxes, lowered taxes on property transactions, scrapped the withhold-
ing tax on interest income and raised rebates for exporters, while taxes gathered from
corporates also continue to weaken as corporate profits deteriorate in line with softening
economic activity.

Consolidation Efforts Taking A Backseat Against this backdrop, we are forecasting China’s fiscal deficit to widen sharply in 2009, to
Budget Balance (% of GDP) CNY740bn (or 2.6% of GDP), as revenue growth slows from 19.4% to 17.0% and expenditure

0.5 growth moves in the opposite direction, accelerating from 25.3% to 26.8%. However, with
risks to government spending weighted to the upside, and risks to revenues firmly skewed

-1 to the downside, we highlight that China could be facing a far larger shortfall.


Nonetheless, we remain confident that China’s budget position will remain within man-
-3 ageable parameters. The central government has been running a fairly conservative fiscal










policy in recent years, meaning that scope to expand expenditure exists, even at a time
e/f = BMI estimate/forecast; Source: Ministry of Finance
when revenues are forecast to suffer. Indeed, central government debt has been estimated
at around 18% of GDP at the end of 2008, suggesting that additional borrowing would be
a viable option to fund the anticipated rise in government spending. Moreover, Wen has
said that a plan to use of some of China’s foreign currency reserves for domestic purposes
is under discussion, and with more than US$1.9trn at its disposal, Beijing’s reserves should
provide an ample source of extra funds.

Efficacy Of Stimulus Package In Question

The recently published breakdown of China’s mammoth fiscal stimulus package has re-
vealed that, in line with our expectations, the majority of the spending will be channeled
into infrastructure projects, with 45.0% of the CNY4trn package to be spent on railways,
highways, airports and power grids, 25.0% to be spent on post-disaster reconstruction and
9.3% on rural development and infrastructure. This equates to approximately CNY3.1trn
being spent on infrastructure projects in their various guises.

Although this will have significant positive effects on employment and the construction
industry over the near term, it is, as we have previously suggested, likely to have a far more


  2004 2005 2006 2007 2008e 2009f 2010f 2011f 2012f 2013f
Fiscal revenue, CNYbn [1] 2639.6 3164.9 3873.1 5132.2 6130.0 7172.1 8319.6 9318.0 10417.5 11594.7
Fiscal expenditure, CNYbn [1] 2848.7 3393.0 4021.3 4978.1 6240.0 7912.3 9075.4 9910.4 10871.7 11893.6
Budget balance, CNYbn [1] -209.0 -228.1 -148.2 154.1 -110.0 -740.2 -755.8 -592.4 -454.2 -298.9
Budget balance, % of GDP [1] -1.3 -1.2 -0.7 0.6 -0.4 -2.6 -2.5 -1.8 -1.3 -0.8
Notes: e BMI estimates. f BMI forecasts. Sources: 1  National Bureau of Statistics, BMI.

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ECONOMIC outlook

muted impact on growth – at least in the short term – than if the money were to be chan-
neled into tax cuts or subsidies, which would have a far more direct impact on consumers.
Moreover, with such a vast amount being thrown at boosting infrastructure, there is a not
insignificant risk of building ‘bridges to nowhere’ (i.e. projects which serve little purpose
upon completion, and whose only raison d’être is to boost short-term employment). While it
is true that China may be able to make those ‘nowheres’ into ‘somewheres’, given the vast
number of underdeveloped settlements outside of the eastern seaboard, the construction of
‘bridges to nowhere’ would nonetheless provide substantial reason for concern.

Indeed, it could suggest that policymakers in Beijing appear to have learnt little from Time Lag Will Be A Key Issue
Fiscal Stimulus Package Breakdown (%)
the ongoing global economic meltdown. China’s growth model of aggressively boosting Ecology and Independent
Environment, Innovation, 4.0
fixed investment and exporting its excess capacity, which has yielded such phenomenally Rural
Affordable Health, Culture
Housing, 7.0 and
successful results over the past decade, is ultimately unsustainable – a fact underscored and
Education, 1.0

Projects, 9.3

by developments witnessed over the past year. To be sure, if China is to achieve a more
balanced growth path over the longer-term horizon, it must shift its focus away from its
external sector and towards building a base for private consumption. However, on this Post-Disaster
Railw ays,
Highw ays,
Reconstructio Airports and
front, precious little progress has been made in recent years. n, 25.0 Pow er Grids,

Source: National Development and Reform Commission

A better option for long-term economic development would be to spend more on building
adequate health and social safety systems. One reason often cited for China’s high savings
rate is that people need to squirrel away money for medical treatment or possible retrench-
ment, given that loss of work has often meant a loss of the social benefits that come with
the job. Thus, in the long term, China could increase consumption by providing a safety
net that would obviate the need for such high savings. However, with only 1.0% of the
proposed fiscal package being spent on health, culture and education, such a policy route
appears to be off the table for the time being.

Moreover, this is merely one of our concerns. The actual size of the planned additional
spending is still under debate, as is the source of financing for the additional spending,
while inherent corruption also remains a key concern. Thus, we remain sceptical as to the
ability of Beijing’s announced fiscal stimulus package to rescue the economy from its
current doldrums.

Exchange Rate Policy

Yuan To Fall By 1% In 2009 BMI View
With the deluge of increasingly dismal data flooding out of China showing few signs of In view of rapidly deteriorating growth prospects
stopping any time soon, we are forecasting the yuan to end 2009 around 1% lower than its in China, we expect the yuan to remain within the
2008 close, at CNY6.9000/US$. Looking ahead to 2010, however, we are anticipating the CNY6.8000-6.9000/US$ range, as the People’s
yuan to once again resume its appreciatory trend as economic growth momentum begins to Bank of China (PBoC) ensures the unit remains
pick up. Yet, we do not believe that the unit will be able to match the 6.9% gains witnessed range-bound in order to promote price stabil-
in both 2007 and 2008, and are subsequently forecasting appreciation of approximately ity and bolster the all-important export sector.
4.5%. This will see the currency end 2010 at CNY6.6000/US$ However, we emphasise the fact that a definite
weakening bias remains in place.
The once enormous upside pressure on the yuan, stemming from persistently colossal trade
surpluses and massive capital inflows, has all but disappeared as economic boom turns to

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bust in China. The years of persistent double-digit growth now look firmly behind us as the
collapse of the Western consumer continues to weigh on demand for Chinese shipments,
which in turn is seeing investment – which has been firmly focused on the export sector
during China’s recent boom period – take a tumble. Despite Beijing’s considerable efforts
– which have included the unveiling of a mammoth CNY4trn (US$585bn) fiscal stimulus
package and 216bps worth of interest rate cuts since September 15 2008 – we remain
sceptical of their efficacy, and as such we have once again revised down our 2009 growth
forecast. Having previously been anticipating a below-consensus expansion of 6.8%, we
have become even more bearish and are now expecting growth to dip to just 5.6%.

Indeed, recent data releases have underpinned our view. Exports fell 2.8% y-o-y in Decem-
ber to compound the previous month’s 2.2% decline, which marked the first since since
February 2002 and the biggest drop since April 1999. Meanwhile, imports plunged by a
Rangebound For Now, But Risks
mammoth 21.3% in December having dropped 17.9% in November, and while plummeting
Weighted To the Downside
Exchange Rate, CNY/US$
commodity prices will to an extent have been responsible, the dramatic fall nonetheless
8.2 underscores not only weakening domestic demand but also a dearth of demand for inputs

for manufacturing exports. In addition, industrial output growth slowed to 5.4% y-o-y in
November, down from 8.2% in October, marking a fifth straight month of deceleration and

7.2 representing the worst monthly reading – excluding the months of January and February
when the Lunar New Year distorts industrial output data – since the monthly data series

6.6 began in 1999. Furthermore, growth in urban fixed asset investment decelerated for a third

consecutive month, slowing to 26.1% y-o-y in the January-December period, from 26.8%
Source: BMI
in the first 11 months of the year, having peaked at 27.6% in September.

Finally, there is increasing anecdotal evidence that unemployment and factory closures are
both rising at a rapid clip. Reportedly, more than 60,000 businesses closed down in 2008,
while in the province of Shandong alone, nearly 700,000 people lost their jobs. With the
liklihood that y-o-y inflation is poised to turn negative in Q109 also thrown into the mix,
there appear few good reasons to expect anything other than a weaker yuan in 2009.

Risks To Outlook
If anything, we suggest that risks to our CNY6.9000/US$ forecast are weighted to the
downside. If growth really slows sharply, and in particular too far below the government’s
8% target, the People’s Bank of China (PBoC) could allow the unit to drop further in
order to try to boost export competitiveness and counter the negative effects of deflation.
Indeed, a one-off devaluation still cannot be completely discounted, although we stress
that this remains a low-probability scenario.

To be sure, a competitive devaluation of the yuan would be a very risky strategy that would
not only risk drawing the ire of the rest of the world – and the US and its new president in
particular – but also potentially provide the catalyst for a series of regional devaluations and
an ensuing trade war. Thus, we continue to believe that the political implications of letting
the currency fall too far will continue to prevent China from pursuing such a policy.

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ECONOMIC outlook

Balance Of Payments
BoP Position To Remain Secure BMI View
China’s all-important external sector ended 2008 on a distinctly sour note after trade data China’s current account will suffer at the hands

for December revealed that both imports and exports suffered a second consecutive month of the global recession, with the country’s overall

of contraction. Exports fell by 2.8% y-o-y, accelerating from the 2.2% decline recorded trade balance shrinking from an estimated

in November, while imports endured a similar fate, plummeting by 21.3% y-o-y having 9.5% of GDP in 2008 to 8.3% in 2009. This will

dropped by 17.9% in the previous month. These developments saw China post a trade sur- see China’s current account surplus fall from

plus of US$39.0bn in December, just shy of November’s all-time high of US$40.1bn, and an estimated 11.8% of GDP to 10.9% over

brought the full year surplus to a record US$295.5bn, 12.7% higher than the US$262.2bn the same time horizon. Meanwhile, mounting

recorded in 2007. concerns over capital flight also threaten the

country’s financial account. Nonetheless, we

Exports to the US (which purchased 17.7% of China’s total exports in 2008) fell by remain confident that despite the mounting

4.1% y-o-y in December to compound November’s 6.1% decline, dragging the full-year downside risks, China’s overall balance of pay-

growth figure down to 8.4%. This marked a notable decline from the 14.4% expansion ments position will remain secure.

recorded in 2007 and a fourth consecutive year of decelerating export growth to the
US, but, most significantly, it marked the first time since 2001 that growth had come in
below double digits.

Meanwhile, exports to the EU (which, with a 20.5% share, was China’s single biggest
export destination in 2008) fell 3.5% y-o-y in December after remaining flat in the previous
month. However, most significantly on this front, the full-year growth figure plummeted to
19.5% from a whopping 49.1% in 2007. With the eurozone forecast to contract by 2.5% in
2009, this figure is likely to fall even further over the coming year. Finally, having already
plunged by 20.1% y-o-y in November, exports to Hong Kong (China’s third largest export
Trade Surplus Has Reached A Peak
destination with a 13.4% share) tumbled 15.4% in December. Trade Balance (% of GDP)

This latest data merely underscores our bearish view on the world’s fourth largest economy, 8

and adds weight to our sharply below-consensus 2009 growth forecast of 5.6%. Indeed, 6

although plummeting commodity prices will to an extent have been responsible for the 4

sharp drop in imports, the dramatic falls witnessed in both November and December also 3

underscore not only weakening domestic demand but declining demand for inputs for 1

manufacturing exports. Moreover, with demand for Chinese goods continuing to weaken










across its key export markets, the current trends appear to have further to run. e/f = estimate/forecast; Source: National Bureau of Statistics,

Indeed, we are forecasting growth of total exports to slow from the 22.3% clip estimated in
2008 to just 12.0% in 2009, with services buoying the headline figure as growth in goods
exports slows from 21.7% to 10.9% over the same time horizon. Meanwhile, although
import growth is also forecast to slow in 2009, it will nonetheless outpace that of shipments.
Imports of goods are forecast to rise by 16.8% in 2009, down from 21.9% in 2009, while
imports of services are expected to increase by 19.3%, slowing from an estimated 30.7%
rise recorded in 2008. These developments will see China’s balance of goods shrink from
an estimated 9.9% of GDP in 2008 to 8.6% in 2009, while the overall trade balance will
fall from an estimated 9.5% of GDP to an anticipated 8.3%.

Although still-strong net transfers and income from abroad will continue to buoy the overall
figure, the weaker performance of exports will drag China’s current account surplus lower

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CHINA Q2 2009

from the 11.8% of GDP figure estimated for 2008 in 2009. However, China’s current ac-
count will nonetheless remain in healthy surplus at 10.9% of GDP.

Risk Of Capital Flight Replaces Concerns Over Hot Money

While China’s current account position will remain secure, the prospects for its financial
account remain far less certain. In the first half of 2008, hot money inflows were perhaps
the single biggest issue facing the Chinese authorities as they attempted to prevent an
Export Weakness To Weigh On C/A economy accelerating from already double-digit growth from overheating. With the yuan
Exports (% chg y-o-y)
60 seemingly only heading in one direction, speculators were falling over themselves to buy
the Chinese currency in the firm belief that they would be making a risk-free profit as the
undervalued unit was allowed to appreciate in order to help curb mounting inflationary

pressures and cool rampant economic expansion. Indeed, the yuan gained 6.4% against the
10 dollar in the first six months of 2008, up from a 4.1% rise in the previous six months and
a 2.6% increase in H107, while the spread of spot CNY over 12-month CNY non-deliver-
able forwards (NDFs) – a leading indicator of investor sentiment towards the Chinese yuan













Source: National Bureau of Statistics

– spiked to a record high of 0.819 on March 13 2008.

While it is nigh on impossible to get hold of accurate figures reflecting the actual amount of
speculative capital entering China, Michael Pettis and Logan Wright, writing in the Financial
Times in July 2008, suggested that the trade surplus, FDI and interest on China’s reserves
accounted for as little as 39% of the country’s reserve accumulation in the January-May
2008 period. This implies that hot money inflows totalled almost US$165bn in the first
five months of 2008. Now, however, as economic boom rapidly turns to bust, the Chinese
authorities are in fact facing the opposite problem: potentially damaging capital flight.

Indeed, Hu Xiaolian, the head of the State Administration of Foreign Exchange (SAFE),
has warned that China faces a threat of ‘abnormal’ cross-border capital flow because of
global financial tumult, cautioning that more money flowing out of the country could in-
C/A To Remain In Healthy Surplus crease the risk of liquidity strain in the economy. In addition, October 2008 saw China’s
Current Account (% of GDP)
foreign exchange reserves fall for the first time since December 2003 when they dropped
to US$1.880trn, having stood at US$1.906trn in September.


8 In a sign of how concerned Beijing is becoming over this issue, the Ministry of Commerce
has proposed in new draft rules that Chinese companies will have to seek ministry ap-
proval if they want to invest US$100mn or more overseas. Under the planned new rules,

which would replace the existing ones promulgated in 2004, companies may also need the










ministry’s approval if they want to invest in countries that have no diplomatic relations
e/f = estimate/forecast; Source: National Bureau of Statistics, with China, foreign infrastructure projects or highly risky countries or regions. Existing
rules require China’s central government-controlled companies to apply for the ministry’s
approval if they want to invest overseas, while other firms need only ask for the permis-
sion of the ministry’s provincial bureaus. These rules do not restrict applications by any
monetary threshold.

In a statement made on its website, the Ministry of Commerce said that ‘the regulations
are drawn up to promote and regulate the development of overseas investments’, after a
few major Chinese companies reported big book losses on investments abroad. However,
it seems that fears surrounding an outflow of capital at a time when economic growth is

22 Business Monitor International Ltd

ECONOMIC outlook

slowing at an alarming pace is also likely to be a prime motive. Indeed, the draft rules also
deleted an existing provision that said that ‘the state supports and encourage companies with
various sorts of advantages and ownerships to go abroad to invest and establish new firms’,
underscoring Beijing’s apparent policy shift. The ministry said the new rules would take
effect after their formal publication, but it did not say when this would happen. However,
Chinese authorities typically issue new rules within a month after seeking public feedback,
which in this case ran until January 20.

While the move will not necessarily stop money leaving China, it nonetheless underscores
Beijing’s growing concerns, and highlights the possibility that a more draconian clampdown
could be implemented going forward. Moreover, it suggests that China’s secure balance of
payments position may be under threat. However, given that China has posted an average
financial account surplus in excess of US$40bn since the end of the Asian financial crisis,
and that its current account is forecast to stay in healthy surplus, we remain confident that
the country’s overall balance of payments position will continue to be secure throughout
the global recession.

Business Monitor International Ltd 23