The Chinese economy is pumped up. And whether Beijing can really wrestle it down is one of the bigger economic dramas in Asia this year. That task falls to Zhou Xiaochuan, the cerebral and seasoned governor of the People's Bank of China (PBOC).
The task is greatly complicated by the fact that Zhou has one arm tied behind his back and confronts a devilishly tricky balancing act. He must gently guide China's scorching economy onto a more sustainable track without triggering a painful bust that could in turn trigger ugly social unrest.
The financial data coming out of China is alarming. Growth in the first quarter hit a torrid 10.3%. On June 12, the government reported that China's global trade surplus hit $13 billion in May, with exports climbing 25% vs. the year-ago period. That brings the tally so far this year to $46 billion, vs. $102 billion for all of 2005.
The acceleration of export earnings, which are eventually converted from foreign currencies into yuan, is creating a tremendous amount of excess cash swirling around the economy. That, in turn, is feeding into ultra-loose bank lending—and by extension—industrial over-capacity and real estate bubbles in Shanghai and Beijing (see BusinessWeek.com, 5/16/06, "Controlling China's Runaway Growth").
Official data on bank loans and loan-supply growth for May aren't out yet. But leaked numbers reported by Shanghai Securities News suggest growth in M2, the broadest measure of money supply, hit nearly 20% year-on-year. That's well above a 16% target set by the central bank. The publication also indicated that some $26 billion in loans were handed out in May, about double the level of a year ago.
If true, "this is all likely to create much discomfort for the PBOC, and is going to cause some nail-biting among economists," notes Stephen Green, a senior economist with Standard Chartered Bank based in Shanghai.
It is also an unwelcome prospect for global investors already worried about slower global economic growth in 2006, as central banks in the U.S. and Europe continue to tighten credit via interest rate hikes and other measures. Asian stock prices are now trading at six-month lows, and Japan's benchmark Nikkei 225 index plunged 4.1% on June 13.
Inflation isn't a huge concern for China just yet. (Consumer prices advanced 1.4% year-on-year in May.) But a boom-bust scenario for a country that soaks up so much of the world's cement, steel, iron ore, and aluminum, and is the third-biggest trading nation, would be another huge shock for the global economy.
Is Zhou up to the task? He's widely regarded as one of the shrewdest political movers in Beijing. His father, Zhou Jiannan, was a minister in the State Council, China's cabinet, in the 1980s and a Communist Party power broker. The younger Zhou has been a force for change since he started serving as an adviser on economic restructuring to the State Council in 1986.
He later did stints as head of China Construction Bank and chairman of the China Securities Regulatory Commission before becoming chief banker in late 2002. In Washington and Europe's capitals, Zhou is viewed as an economic reformer who understands the economic devastation that deflated economic bubbles can wreak.
Yet there may be little he can do other than issue verbal warnings to Chinese banks and local government officials eager to finance yet another trophy highway extension or gleaming skyscraper. To cool things off, China must either engineer a significant appreciation of the yuan vs. the dollar or raise interest rates steadily for some time to come. Neither option is appealing to the government of Chinese President Hu Jintao.
True, the yuan has edged up against the dollar in recent weeks, and the PBOC and other financial regulators are taking steps to let market forces shape the currency's day-to-day trading range. China's State Administration on foreign exchange recently eased limits on how much overseas currency Chinese companies can use to make foreign acquisitions.
IN REAL ESTATE
But nobody expects Hu's government to sign off on the 20%-plus appreciation of the yuan that some economists say is needed to make a meaningful dent in the trade numbers. And a big increase in foreign food imports (made more competitive by a sizable appreciation in the yuan) could devastate China's agricultural sector, a massive employer of low-wage workers. The mainland's industrial exporters would be outraged too.
Raising interest rates, something that Zhou has hinted isn't in the cards short-term, would also be extremely risky. A huge chunk of Chinese household savings and national investment is tied to the mainland's over-extended property market.
PBOC deputy governor Wu Xiaoling has warned publicly that the value of total private and commercial investment in real estate shot up from about 2.5% of total gross domestic product in 2001 to 8.6% in 2005. "e;Real estate bubbles will affect the economy and people's lives seriously, especially when bubbles burst,"e; Wu said in a late-April speech to an international housing conference in Beijing.
Instead of a rapid round of interest rate increases, Beijing in June rolled out a series of decrees aimed at containing the luxury real estate market, where most of the speculative excess occurs, and steer more funds into affordable housing. The measures boost the minimum down payment to 30%, up from 20%, on homes larger than 900 square feet.
To discourage rapid flipping of apartments, a tax of 5.5% is being slapped on the entire purchase price of any property sold within five years, up from two years (see BusinessWeek.com, 6/19/06, "China: The Starter Home is a Non-Starter").
UBS Asia chief economist Jonathan Anderson thinks the PBOC may also raise the levels of reserves that banks must keep with the central bank. Still, it will take more than a mix of interest rate hikes and yuan appreciation to get China's economic growth down to a more manageable level of 8% to 9%. That will require some tough choices that Beijing has so far been unwilling to make.
If money supply and loan growth keep growing unabated, at some point there will be a price to pay. And any contraction spurred by a property-bust in China would be felt far and wide in the global economy.