Global Insight Perspective | |
Significance | GDP grew by 10.7% in annual terms in 2006 after posting growth of 10.4% in the fourth quarter. |
Implications | Investment remained the main driver of growth as huge foreign capital inflows generated by exports and direct investment fuelled liquidity growth. While consumption strengthened, the continued skewing of growth has raised concerns over levels of excess capacity in the economy and the threat of a new generation of non-performing loans. |
Outlook | To contain those risks, further measures will be implemented to tighten the money supply and cool investment growth, building on the slowdown apparent in the second half of the year. However, the economy’s momentum will remain robust, with growth forecast at around 10.0% in 2007. |
Unremitting Momentum
The juggernaut economy continued to roll in 2006. At a press conference in Beijing, the National Bureau of Statistics (NBS) reported annual GDP growth at 10.7%. This marked the fastest rate in growth since 1995. In the three months through to December, the economy expanded by 10.4%, slowing from 10.6% in the third quarter and a peak of 11.5% in the second quarter. The announcement follows the upgrading of the 2005 growth figure to 10.4%. The NBS reported year-end GDP in nominal terms at 20.94 trillion yuan (US$2.69 trillion).
Investment and exports continued to be the central source of momentum. Investment has fuelled the economy’s buoyant growth cycle since 2002, boosted by high levels of liquidity in the financial system. Money supply has been buoyed by central bank interventions to sterilise the impact of huge foreign capital inflows, generated by investment and exports, on the fixed exchange rate. The trade surplus widened in 2006 as imports slowed and exports retained significant traction. Foreign direct investment (FDI) inflows totalled US$63 billion in 2006, a 0.5% increase on the previous year. Total foreign-exchange reserves broke the US$1-trillion threshold.
The boom in investment has threatened to aggravate over-supply in the economy, while accentuating credit risks in the state banking sector. After administrative controls had limited success in curbing investment growth, monetary policy was tightened; interest rates were raised in April and August 2006 by a cumulative 0.54%, while the reserve requirement ratio has been lifted by a total of 200 basis points since June 2006 in 50-basis-point increments.
Fixed Asset Investment Slows, but Further Measures are Required
The measures appear to have had some effect, while attempts to even out investment growth across the country also met with some success. Some two percentage points were trimmed from the year-end growth rate in fixed asset investment (FAI), with the NBS reporting annual growth of 24% for 2006. Urban FAI growth came in slightly ahead of this rate, with a 24.5% year-on-year (y/y) increase reported.
In geographic terms, FAI in central China grew at a reported 33.1% y/y, a modest 0.4 percentage points above the rate reported for 2005, with slowing rates of FAI growth reported for coastal and western regions of the country. Capital spending growth in coastal regions slowed by 3.4 percentage points to 20.6% y/y, with a 4.7-percentage-point decline to 25.9% y/y reported for western regions. The slowdown became more pronounced in the second half of the year. At the end of the second quarter of the year, FAI growth was running at 31.3% y/y. However, pockets of overheating persist. Investment in the closely watched real-estate sector is reported to have risen by 21.8% y/y, an increase of 0.9 percentage point over the rate of growth reported for 2005.
Rebalancing Growth
Policy has aimed at rebalancing domestic demand growth away from investment to consumption, which as a share of GDP has fallen to around 40% from over half at the beginning of the reform period in the late 1980s. By contrast, in India, consumption accounts for around 61%. As stated before, the intensive model of economic development has fuelled excess capacity in the economy, while productivity levels remain relatively low. At the same time, employment generation has been comparatively modest, in turn undermining consumption growth. Growing inequalities of wealth represent a growing challenge to the legitimacy of the ruling Communist party. Finally, the intensive model of economic development is resulting in severe economic degradation.
Some progress was made towards this rebalancing in 2006. Retail sales, a rough proxy for consumption, increased by a reported 13.7% y/y. Complete data for retail sales was not provided in official information releases, though noted during the press conference were the 36.2% y/y increase in sales of refined petroleum products, the 26.3% y/y increase in vehicle sales, the 24% increase in construction and decorating materials, and the 22% y/y increase in sales of communication equipment.
The NBS reiterated that among its key policy goals for 2007 is reforming the "system of income distribution" to foster higher levels of consumer spending in the vast middle-income category. However, income disparities continue to widen. Urban residential incomes increased at a reported nominal 12.1% in 2006, or at a real 10.4% y/y pace once price factors are taken into consideration. A more modest nominal growth rate of 10.2% was reported for per-capita rural net income, which translates into a 7.4% real increase taking price factors into consideration. Although it would appear to run counter to employment trends cited in earlier reports from various agencies of the Chinese government, official registered urban unemployment increased by just 0.1 percentage point during 2006 to 4.1%.
Outlook and Implications
Although moderating, the economy enters 2007 with a substantial tailwind behind it. Global Insight forecasts a modest deceleration in growth in 2007 to around 10.0%. External demand should moderate slightly as growth in the United States slips below trend following a stronger-than-expected correction in the U.S. housing market. Changes to the tariff structure amid growing criticism of China’s export strength may also blunt external sectors. Concurrently, further measures are expected to tighten money supply and curb credit growth through further rises in the deposit reserve ratio and interest rates. The rationale for additional monetary tightening has been boosted by a pick-up in inflation in 2006. Although rates of inflation remain low relative to the economy’s growth, price movements remain a highly sensitive political issue. In December, consumer price inflation stood at 2.8%, its highest level in almost two years.
However, attempts to slow growth will be weighed against other considerations. The Chinese Communist Party (CCP) will hold its 17th national congress later this year, during which the fourth-generation leadership will seek to cement its position. Aside from such political motivations, maintaining high growth rates is necessary to absorb the effects of continued restructuring. It is by this same token that major adjustments in the yuan exchange rate are not expected. Placing growth on a more sustainable path over the long term depends on far-reaching reform of the rump state sector, the social welfare system and financial markets; reforms which by their very nature pose a tricky political challenge to the CCP.