Not yet rebalancing

The ADB’s report on China confirms something that Nick Lardy has been staying for a while: China’s efforts to “rebalance” its economy – that is to shift the basis of its growth away from investment and exports– aren’t working.

Chart 2.8.1 has the story.   By slamming the breaks on investment – with administrative curbs on what local governments and firms can do as well as limits on bank lending – China has reduced the contribution of investment to growth.    But rather than shifting the basis of domestic growth toward consumption, China offset a smaller contribution from investment to growth with a larger contribution from net exports.    Net exports – eyeballing the data – contributed about 3% to China’s growth in 2005, and only a bit less in 2006.  The combined contribution of investment and net exports to growth didn't change. 

Don’t get me wrong.  Consumption is growing, and no doubt growing faster in China than in the US.  But private consumption makes up a much smaller share of China’s economy than the US economy – about 40%.   10% real growth in private consumption would generate about 4 percentage points of overall growth.  Good.   But no enough to sustain 10% of GDP growth.   And, as table 2.8.17 shows, consumption (private and government) continues to fall as a share of China’s GDP, while investment continues to rise.  

Steps to restrain bank lending and otherwise curb investment have kept investment from rising as fast as it did in 2003 and 2004, but they haven’t prevented investment from creeping up to close to 45% of China’s GDP.   With a current account surplus of around 9% of GDP, China is now saving (implicitly, the actual data doesn't quite add up) close to 55% of its GDP ...

Has China’s government done all it could to encourage rebalancing?  My answer is no.   The RMB did rise by around 3.3% against the dollar in 2006, but on a broad trade weighted basis, it still depreciated by 1.6% in real terms.  China now trade a lot with Europe, and the RMB fell significantly against the euro and the pound in 2006.

Government spending grew at an impressive clip, but revenues grew even faster.  China’s fiscal deficit fell.  

At least its on-budget deficit.   Someone should start accounting for the off-budget subsidy for the global consumption of China’s goods that China’s central bank provides Chinese exporters by holding the RMB down -- what Bernanke called a de facto export subsidy.   Maybe accounting for future losses as they are accrued would encourage China to shift from subsidizing the world’s consumption of Chinese goods to subsidizing Chinese consumption of Chinese goods.    

Alas, I don’t see much evidence that China is about to change its approach.  The ADB forecast that China’s export growth would slow in 2007.  The available data – admittedly somewhat puzzling – shows a strong rise in export growth in the first two months of the year.  Q4 export growth was also quite solid.  Net exports look set to contribute more to growth than the ADB forecast.   The dollar’s recent weakness – read the RMB’s recent weakness – won’t help slow Chinese export growth.   China continues to rely on various efforts to contain investment to keep the economy from overheating.  That seems like the same approach that has been tried before.  Restraining investment while the currency is kept down keeps the economy from overheating, but it pushes up the current account surplus. 

Jon Anderson of UBA now estimates that China’s current account surplus is above 10% of GDP – and that China’s basis balance of payments has a surplus of close to 15% of GDP (the basic balance includes net FDI inflows).    That is, by any measure, quite large.   Anderson thinks China’s current account surplus is about to come down.  I hope so.  It is reasonably to think that a surplus this large cannot get even larger.   But I don’t really see much evidence that is in the cards.   Not yet. 

The ADB also highlights how difficult it will be for China to shift from financing the US through its central bank to financing the rest of Asia through a new investment company.   The ADB (see the statistical appendix) forecasts that China’s 2007 current account surplus will rise to around $270b.   That looks to be on the low side.   $300b is likely.    But the only emerging Asian economy forecast to run a significant current account deficit is India.  And India’s deficit is “only” around $20b.  It has had no trouble attracting far more capital than that even without inflows from China     Both Southeast Asia and Northeast Asia (setting China aside) are forecast to run solid current account surpluses.   Unless something changes, big time, they won’t need financing from China.    

Surpluses – in equilibrium – have to go to finance deficits, not to countries with surpluses of their own.  And Asia – even without China -- is a surplus region.  Recycling China’s surplus within Asia would require major policy changes in other Asian economies, not just in China…  The US, by contrast, is very accustomed to receiving a generous credit line from the PboC … it truly needs the money.