China 2009: The Confidence Deficit

Stock markets fell some 65% in 2008. Growth is down, unemployment is up. Will Beijing try to buy its way out of its problems with more exports?

It's a question that has economists worldwide scratching their heads: What will happen to growth in China in 2009? While some are predicting economic expansion in the mainland will slow to less than 7%, others are still hoping GDP gains will be 9%-plus.

The optimists assume China will be able to buck collapsing U.S. and European demand for its phones, TVs, sneakers, and myriad other products. Their biggest hope is Beijing's $586 billion stimulus program, announced in November. Just as important—though perhaps less likely to pay off quickly—are China's consumers. With more infrastructure spending, expanded social welfare programs, and directives ordering banks to lend, China's consumers and companies will rise to the occasion and spend more—or so the theory goes.

A quick perusal of the latest Chinese economic indicators doesn't bolster one's faith. In November, China registered a 2.2% drop in exports. That's the first decline since 2001, and the trend is likely to continue throughout 2009. Industrial production growth slowed to 5.4% in November, the lowest level since February 2002. And manufacturing activity continued to slide for a fourth consecutive month, with a PMI (Purchasing Managers' Index, a monthly survey measuring China manufacturing activity, compiled by CLSA Asia-Pacific Markets) of 40.9 in November, down from 45.2 in October. After months of worry about inflation, China now may be heading toward deflation, with prices up only 2.4% in November.

An Unhappy 2008

Reversing the decline will depend on confidence. Even as the world economy will likely continue to struggle in the New Year, China is counting on consumers to lift still-strong retail sales. Confidence, however, is just as rare a commodity in China as in the rest of the world.

China's city dwellers aren't looking back at 2008 with fondness. Chinese stock markets fell some 65%, ripping a hole in many a nest egg. Real estate prices have slid by as much as 10% in Shenzhen and other cities, and are flat at best in Beijing and Shanghai, says China's National Bureau of Statistics. Throw in continuing worries about rising health-care and education costs and it's no surprise that the national data collecting organization recorded a 4%-plus drop in consumer confidence in October, as compared to the same month a year earlier. As recently as July, consumer confidence was growing, but those days now seem long ago.

And for China's vast legions of rural residents and migrant workers, confidence in the future is also in short supply. As millions of migrant workers head back to the countryside early for Chinese New Year (Jan. 23), many will likely arrive without the mountains of gifts or cash-filled envelopes they typically bring home for the holiday.

Unemployment Surge Expected

That's because as the export downturn rips into provinces such as Guangdong, factories are shutting their doors, often leaving workers unpaid. As many as 70,000 small and midsized companies may have gone bankrupt in the past year, estimates Jeongwen Chiang, associate dean of the Cheung Kong Graduate School of Business in Beijing. Overall, Chiang thinks the bankruptcies could grow to 20% of export-oriented manufacturers in southern China. "Someday the growth engine was going to stop, and they weren't ready for it. They don't know how to handle a recession," warns Chiang.

The bankruptcy trend is expected to lead to a surge in unemployment in 2009. And there aren't many agricultural jobs waiting for laid-off migrant workers either. McKinsey & Co. estimates that another 300 million rural residents must come to Chinese cities over the next seven years.

Already, this year's 5 million university graduates are struggling to find whit-collar jobs. "The current employment situation is still grim," Yin Weimin, minister of human resources and social security said at a November press conference in Beijing. "In the first quarter of next year there will be even greater difficulties," he said, citing bankruptcies affecting migrant workers as one key factor.

In a demonstration of weakening consumer confidence, tens of thousands of migrant workers have taken to the streets in southern cities like Dongguan and Shenzhen, blocking traffic and demanding they get paid back wages. Strikes by taxi drivers have flared in Guangzhou and the southwestern city of Chongqing. That has local officials taking steps to contain the unrest. In Dongguan, the local labor office has stepped in to pay some worker wages. And in Chongqing, former Commerce Minister Bo Xilai met for three hours in November with representatives of the striking cabbies to address their concerns.

Beijing, of course, is hoping that its planned vast infusion of spending—over half a trillion dollars into infrastructure including roads, railways, and low-cost housing—will create jobs and keep consumers spending. The government also has ordered banks to lend more, with a goal of $588 billion in total loans for 2009. And money-supply growth next year is targeted at 17%, up from a November rate of 14.8%, year on year. In mid-December the State Council issued a series of policies aimed at encouraging that expansion, including expanding corporate bonds related to infrastructure and giving banks more freedom to set lending rates. And on Dec. 22, China's central bank cut interest rates for the fifth time since September, lowering the benchmark one-year lending rate and deposit rates to 5.31% and 2.25%, respectively. "When the central government mandates a certain growth rate, the locals [governments] jump," says David Li, director of Tsinghua University's Center for China in the World Economy. "That's the easiest way to create growth."

That may indeed ensure growth in infrastructure-related investment, which in China makes up 25% of total fixed-asset investment, according to Jing Ulrich, managing director of China equities at JPMorgan (JPM) in Hong Kong. But the challenge will be seeing the same boost in investment tied to the property and manufacturing sectors, which make up 24% and 32% of total investment, respectively. Both are reeling from excess capacity. Sales of commercial real estate fell by 19.8% in the first 11 months, while residential sales declined by 20.6%. Meanwhile, industrial sectors from steel and autos to electronics, toys, and textiles are all facing massive inventory gluts and falling prices. Indeed, China's fixed-asset investment growth through November already declined to 26.8% as compared to 27.2% for the first 10 months. "We expect lower investment in the near term as the export sector grapples with weaker demand and property developers focus on clearing their existing inventories," Ulrich wrote in an analysis on Dec. 16.

Up to the Government

So don't expect confidence to start infecting companies in China, either. And even if they were inclined to boost their spending, it is unlikely China's lenders will suddenly start shoveling capital to all of them. When it comes to making loans, China's state-owned banks continue to favor larger, state-owned enterprises to the detriment of China's private companies, a habit unlikely to change in an ever more uncertain economic climate rife with bankruptcies, too. "Households cannot expand demand, businesses cannot expand demand—so it is left to the government to do it," says Michael Pettis, professor of finance at Guanghua School of Management at Peking University.

That worries Pettis: He cites both the slowing pace of appreciation of the yuan and the reinstatement of a host of export rebates as signs that Beijing instead may try to support economic growth by boosting exports, a move that could spark waves of global protectionism. "If China makes the same mistakes the U.S. did, and thinks they can export their way out of this problem and don't have to massively boost domestic demand, then we have a repeat of the 1930s. So far China is acting like it thinks it can export its way out of this problem. I am very, very worried," says Pettis, who is predicting that China's growth will fall below 7% in 2009.

Before it's here, it's on the Bloomberg Terminal.