The next shock to the global economy, already reeling from recession, could come from China, which witnessed excessive ‘malinvestment’ during the boom years and where the investment structure is collapsing rapidly, says economist and Asianomics founder Jim Walker. India, on the other hand, will probably grow by 3-5% in 2009, which given the economic contraction or tepid growth elsewhere could possibly be the world’s highest, he reckons. Excerpts from the first of a two-part interview that Walker gave DNA in Hong Kong on Tuesday:

Two years ago, you said, ‘The butterfly has flapped its wings in subprime USA; the hurricane will be felt in rustbelt China.’ Have we seen the worst of the hurricane? Some analysts are flagging a recovery there.
Quite the reverse. I think things are unravelling quite fast in China. Obviously, the export sector has been hit hard, and the trading goods sector is struggling. But when you look at the data in China, what is perhaps even more interesting is how quickly imports are collapsing relative to exports. In fact, China’s trade surplus is going up. That tells you that domestic demand is falling faster than external demand.

The biggest problem, we’ve always felt, is that the signals being sent in China in terms of the industrial sector were that it should be export-orientated and it should be capital-intensive; in other words, the exchange rates were undervalued and interest rates were too low.

At this stage, external trade is shrinking; at the same time, the capacity that has been put in place in China by private investment is being shown to be overcapacity and bad investment. The investment structure in China is coming down very, very quickly.The government has underestimated the impact of this on economic growth. Bear in mind that when investment comes down — as it always does in a business cycle — it doesn’t go from 20% growth to 10% growth; it goes from 20% growth to 20% contraction. That’s the process we are seeing in China now.

We have the two biggest drivers of the Chinese economy — trade (the export sector) and investment — absolutely collapsing. It’s too early to talk of a recovery in China; we haven’t even really got anywhere near the depths of the recession.

Will the 4 trillion yuan stimulus package add to ‘malinvesment’?
The biggest danger is that it will go to the wrong industries and the wrong places, not the ones that are not efficient or profitable, which means eventually they will become bad debts in the banking system.

The banking system is perceived to have slack, loans-to-deposit ratios are relatively low, so there’s a big push to get banks to lend. The big difference between the mid-1990s and now is that banks are now listed. What you’re going to do is use money that’s partly owned by investors — foreign and local — to support economic growth; whether that money will ever be repaid or not is immaterial. Basically, banks are being used as a policy tool. That makes equity investments in China a very dangerous proposition for a long number of years. China is really in danger of making foreign investors disappear for some time.

At the same time, that 4 trilliion yuan is enough to raise economic growth rate. Our forecast is that in 2009, China GDP will grow between 0 and 4% GDP growth, with a 30% possibility that it will be negative, and 0% possibility that it will be 8%.

That 0-4% projection assumes a huge effort by the government to spend money. What it has to overwhelm on the private sector side is gigantic. In any case, they are not going to be able to spend 4 trillion in one year; a lot of that is actually not new spending.

Work report effectively spoke of 1.4 trillion yuan in new spend. That’s about 4.5% of GDP. That should, with a bit of luck, keep them at 0-4%

How will this recession manifest itself in China?
Empty factories, mothballed production lines, increased unemployment.

For what period of time? Where will demand come from when it revives?
These are the hardest questions for China at the moment. It’s not too difficult to make a case that China may be the worst-affected economy in the world. And that’s still ahead of us.

In 2007-08, China’s current account surplus was 10-11% of GDP. That told us that in order to balance domestic supply and domestic demand, China had to export 10-11% of its economy. That is a very big imbalance.

Now, with the rest of the world in recession, exporting 10-11% of your economy is not going to happen. It’s a question of what percentage of that 10-11% needs to be destroyed in terms of capacity reduction to balance domestic supply and domestic demand. There’s still going to be some external demand. This could a very severe problem that takes 2-3 years.

But beyond the next 2-3 years, when the malinvestment gets sorted out, are you bullish on China?
That’s always been my hope. But I am more concerned about the policy response in China -not just now, but over the past 2-3 years. If anything, China has been going backward in terms of policy management for at least two years. It was unwilling to allow oil prices to find their proper levels when they were rising fast last year, and it’s been getting banks to lend in a way that makes them ‘handmaidens of national policy’ . That’s very dangerous because capital is already mispriced, and interest rates are not set by the market. Secondly, the kind of people they want banks to lend to have a bad track record of repaying.

So, policy direction in China has not been consistent over the past five years. It was moving strongly in a market direction from 2002 to 2005, but by 2006, they stopped going down that that track, partly by balancing the currency appreciation with all sorts of offsets.

Does that influence your long-term view on China?
It’s making me more concerned than I was two or three years ago. Unless they begin to reverse their interventionist tendencies, this could be a longer crisis. It would signal to people that China is just too immature to be investing in. For now, however, they’re still starry-eyed about China.

source: DnaIndia

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