1. Chinas Economy in the Post- Crisis World Carnegie Endowment for International Peace Washington DC, 17 March, 2010 Pieter Bottelier

2. Main points 1.Chinas stimulus program is huge and has been very effective. 2.Since March 2009 output-, employment- and confidence indicators have continuously improved. 3.But problems have arisen: inflation, property bubbles, housing affordability, trade tensions. 4.The government recently embarked on a cautious exit strategy from credit-driven stimulus program. 5.Barring major policy mistakes and assuming no second dip in US,EU, near-term growth prospects are good. 2

3. Main objectives of stimulus program 1.Quickly revive employment and stimulate domestic demand (to compensate for falling exports) through: - massive consumer loan- and subsidy programs - infrastructure investment, especially in less-developed provinces - revival of urban real estate markets 2.Reduce Chinas dependence on consumer markets in the West by: - promoting South-South trade and investment - tightening economic relations between the Mainland, Taiwan & HK - promoting internationalization of the RMB 3

4. Quarterly GDP growth y/y & q/q 4

5. What explains the success of Chinas stimulus program so far? The program was well designed, initiated only 6 weeks after Lehmans collapse and generously funded, especially with bank credit. China was not overleveraged like the U.S. Stimulus money immediately translated into incremental aggregate demand. Governments at all levels had relevant experience, and the countrys fiscal position was strong. Central and local government interests were fully aligned. After 10 years of intensive reform, Chinas commercial banks were in good condition and had ample liquidity. 5

6. Chinas stimulus-driven growth pattern is obviously not sustainable M2 and credit expansion in 2009 over 30%! Investment accounted for 8 ppts out of 8.7% GDP growth in 2009. Domestic demand in 2009 grew 12.3%! (i.e. 8.7% plus 3.6% negative contribution of net- exports). Note: unsustainability is in the nature of stimulus programs. 6

7. The stimulus program was mainly debt- financed 7

8. The allocation of stimulus funds is not yet known, but a rough guess is: (source: Bottelier) Infrastructure : 50% Low-cost housing and other real estate: 20% Corporate investment and working capital: 9% Consumer loans and -subsidies: 10% Additional spending for social sectors: 7% Tax reductions and other: 4% Note: Government tried to avoid channeling significant additional resources to industries already in excess capacity. 8

9. Is China is getting over-leveraged? 9

10. Downside risks – Rising consumer price inflation, 2.7% in February y/y. – Rising producer price inflation, 5.4% in February y/y. – Rising wages due to labor shortages! – High leverage in the construction sector. – (Leverage in the household sector is rising, but still low; average mortgage loan/value ratio under 50%). – NPL growth in the years ahead. – International trade protectionism. – Sino-US tensions over Taiwan arms sales and other issues. – Reduced international business confidence (although FDI is still increasing). 10

11. Share prices rose fast in 2009, but are not in bubble territory 11

12. Uncertainty about local government debt Borrowing by local government-owned construction companies (investment groups) is not recorded as public debt. Total de-facto local government debt could be as high as 30% of GDP (Victor Shih). But mitigating factors are: 1.Loans are backed by real assets (usually land); 2.Many projects are revenue-earning; 3.Assets and liabilities all within the public sector. 12

13. Uncertainty about the extent of urban property price increases High-end residential markets in bubble territory, but full extent of problem is not clear Commercial property prices have peaked; is it true that this is not causing problems for banks? Head of NBS admitted to NPC delegates that house price index for 70 major cities may be faulty. 13

14. This is the chart that NPC delegates did not believe – according to poll, housing affordability has sharply declined and is top public concern 14

15. Chinas trade surplus in 2009 reduced by one-third – to $196 billion. Not clear what lies ahead. 15

16. Is China serious about rebalancing its growth model? Yes, but it will take years and require additional policy changes, including exchange rate and interest rate action. The national savings rate (50% in 2008!) will have to come down. Since 1999 too much investment went into manufacturing; this contributed to Chinas large trade surplus and excess capacity problem. The government is trying to reduce Coast-Interior imbalances by concentrating infrastructure investment in less developed provinces. Income inequality and wealth gaps will probably continue to widen for some time. 16

17. The problem does not lie in slow consumption growth, which is perhaps the highest in the world 17

18. In 2009 private consumption and total consumption grew faster than GDP Central government spending on social sectors increased sharply (e.g. health +48% and education +28%). Private consumption also grew fast (probably over 9%), but may slow when subsidies and loan programs are throttled back. 18

19. International experience suggests that a countys consumption/GDP ratio begins to rise when per capita income reaches about $9,000 (in PPP) – China is close 19

20. Concluding thoughts The U.S. has ceased to be a model for Chinas economic reforms – this has both economic and political consequences. The crisis has confirmed the governments belief that the state should have a major role in the economy. China is trying to reduce dependence on Western consumer markets. China will reduce economic imbalances, but slowly. 20