Evidence of Continued Weakness in Chinese Economy
Summary:
The Chinese economy continues on a downward trend reflected and amplified by falling foreign direct investment. Beijing's latest strategy to remedy this situation and restore foreign confidence in the Chinese economy is by encouraging domestic consumption and investment. The problem is, Chinese citizens are not going along with the plan, preferring to deposit their savings in the perceived safety of banks, despite recently slashed interest rates. Far from riding out the Asian economic collapse and preparing for brighter days, China has merely delayed the full impact of that collapse into which it is now being dragged by declining foreign and domestic confidence.
Analysis:
According to the June 29 issue of Asia Pulse, China's State Statistics Bureau reported that exports in April fell 7.3 percent versus the same period the previous year. Fixed asset investment by the public and other sectors of the economy fell by 7.7 percent, month on month, in April. And while the consumer price index fell by 2.2 percent and the retail price index fell by 3.5 percent in April from the previous month, retail sales were relatively unchanged from March. According to a June 25 report by China's Xinhua news agency, citing State Administration of Internal Trade figures, retail sales fell 1.7 percent in May from the 7 percent growth of the preceding four months. Where money in China is going is clear from the Statistics Bureau report that bank savings by individuals stood at 5.84 trillion yuan, up 0.4 percent from March and 19.2 percent versus the previous April.
China's official International Business Daily, citing trade ministry figures, reported June 28 that paid-in foreign direct investment in China fell 6.6 percent and pledged foreign investment fell 17 percent in the first five months of this year from the same period in 1998. The daily attempted to put a positive spin on the figures, noting that paid-in foreign investment in May was up 15.6 percent from May 1998, the first monthly increase this year. However, paid-in investment in January through April of 1999 was down 12.6 percent year on year. Approvals of new foreign-funded enterprises in China were down 13.6 percent during the first five months of 1999 from the same period the previous year. The Economist Intelligence Unit expects paid-in foreign direct investment in China to drop to around $30 to $35 billion in 1999 -- the lowest yearly amount since 1993 -- from $45.5 billion in 1998. Beijing reportedly cited the Asian economic crisis, a global slowdown in investment, turbulence in the international financial markets, and slow growth in the Chinese economy as the culprits behind the downturn in foreign direct investment in China.
Prime Minister Zhu Rongji's strategy to lift China out of this slump is to attempt to stimulate domestic investment and consumption. Chinese media have touted the recent increases in China's stock markets, expressing the hope that the bull market will attract domestic investment and the ensuing returns from those investments will launch a consumer spending surge. A front page commentary in China's official People's Daily on June 15 called the rally that saw China's stock markets skyrocket 80 percent in six weeks "sustainable," and urged Chinese to invest still more. Beijing sparked the rally by cutting transaction taxes on some shares and by creating two new mutual funds. China is also apparently turning a blind eye to domestic companies illegally routing money through Hong Kong and back into the Chinese stock markets.
To encourage both consumption and investment, China slashed interest rates for the sixth time in three years. Effective June 1, the Peoples Bank of China slashed the average interest rate for bank deposits by one percent and the average interest rate for loans by three quarters of a percentage point. The benchmark lending rate now stands at 2.25 percent. In a report to the National People's Congress on June 26, Finance Minister Xiang Huaicheng announced plans to increase China's economic growth by raising salaries, adjusting taxes, encouraging exports and domestic consumption, and attracting foreign investment. Xiang warned that revenue growth could slow in the second half of 1999 unless weak domestic demand and capital spending and declining exports were effectively addressed.
The trouble is, the strategy is not working. According to a survey by the Beijing-based Investigation Institute on the Chinese Economy, released June 29 by China Daily, about 56 percent of urban Chinese are choosing to maintain or expand their bank savings, while only 8.2 percent have put money into China's stock markets. Only 36 percent of the respondents said they intended to withdraw any money from their bank accounts. Most cited upcoming education, housing, and medical expenses as the reason for their reluctance to invest or spend. Additionally, some 30 percent of those surveyed expected their income would grow slower over the coming year. Left unspoken was the fear of unemployment and mistrust of China's stock markets, and the survey did not address the spending habits of China's rural population, which does not have much disposable income anyway. The fear of ongoing labor cutbacks and slow growth has also made Chinese banks reluctant to lend, thereby contributing to stagnant consumption.
Beijing has blamed slow growth in the Chinese economy for turning away investors. To address this, Beijing is attempting to spur domestic investment in stocks, thereby pumping up the equity of Chinese companies and making it easier for them to borrow on the international market and to lure foreign investors. Beijing is also hoping that a surge in consumer spending will make investment in China more attractive. But, China's fundamentals weigh against dramatic increases in foreign investment, and its barefaced attempt to improve the national balance sheet by inflating equity values -- reminiscent of similar attempts by other Asian countries to artificially inflate real estate values -- is unlikely to inspire foreign investment. That is even assuming that Beijing is able to drum up more domestic interest in the markets, something not altogether apparent at this time. And as its stock market rally runs out of steam in the face of lackluster foreign and domestic interest, China may see a major reversal in the markets, only amplifying its problems.
China's difficulty attracting foreign investment illustrates the fact that what Asia is currently experiencing is a cyclical upturn in a secular downturn. While some Asian economies may truly have bottomed, either because they did not have far to fall or because they underwent some degree of painful but necessary reform, many have far more room to fall. Those countries that have dealt less ruthlessly with their financial problems, which have not imposed stringent reforms, are merely experiencing a temporary respite from their downward trend. We think particularly of China -- struggling to bolster its balance sheets with domestic investment and consumption, Japan -- addressing a banking crisis by nationalizing the problem and using all means including make-work programs to lower the rate of unemployment, and Malaysia -- whose resort to restrictions on capital flows expires in September.