So now it’s official, Japan has slid into recession, while China is spending itself silly — or at least, it’s trying to look as though it is, with numbers artfully arranged to achieve the impressive headline figure of an Rmb4,000bn two-year fiscal stimulus package which appears to be some existing spending plans topped up with new and modest extravagances here and there.
Even so, Goldman Sachs analysts suggest in a note this week, Chinese fiscal expansion could actually help a recovery in Japan’s capital goods exports, which account for 50 per cent of all its exports.
It seems doubtful - even fanciful - but Goldman is bullish on the prospect. While China and the rest of Asia have been driving Japan’s overall exports in recent years, flagging momentum in Japan’s key US and Europe markets has been taking its toll. In particular, slowing Chinese domestic demand coupled with an ongoing inventory correction has hit Japan’s all-important exports of steel, semiconductors, and capital goods such as general and construction machinery - which alone account for 50 per cent of its total exports, says Goldman.
This has driven a pronounced slowdown in the Goldman Sachs Global Leading Indicator, a predictor of export production trends, which fell 1.4 per cent YoY in October (vs. 0.0 per cent in September).
Assuming that infrastructure-related spending accounts for a significant portion of China’s new fiscal expansion programme, it could have a “considerable impact” on capital goods exports, chiefly general and construction machinery, says the GS team.
Largely on the strength of this anticipated “China boost”, Goldman estimates a recovery in Japan’s exports to China, now showing virtually zero growth compared with growth of +10 per cent in 2007. Such a boost, together with the ripple effect of this on production, would boost Japan’s own GDP growth by about 0.3 percentage points, Goldman ventures.
So what about Beijing’s all-singing, all-dancing stimulus package? As the FT reports, China backed down on Friday to (sort of) clarify its initial announcement and admit that the actual new-spend component of the package would only amount to a little over a quarter of the announced Rmb4,000bn ($586bn)
As the FT’s Asia editor, David Pilling observes, Chinese statistics and Chinese milk packaging have something in common. “Do not believe what you read on the label”.
Either way, even with just $172bn worth of new spending included, the overall package has provided hours if not days of fun for economists and commentators, who have been drawing up assessments and projections of its likely impact, both domestically and abroad.
The views, unsurprisingly, range from underwhelmed to optimistic. The truth, as usual, is probably in between.
CLSA noted last week, after it had slashed its outlook for China GDP growth next year to 5.5 per cent from 8 per cent, that it still incorporates 2-3 per cent of GDP growth for “aggressive government stimulus”.
On the key question “will the plan work”?, CLSA notes the question largely depends on the extent to which large parts of the Chinese economy have spun out of the government’s control: “The world has never been so integrated, we have never seen such a co-ordinated slowdown and China has never been so geared to exports and private sector spending, all aspects beyond the government’s control.”
The bottom line, according to CLSA, is that the Chinese government is having “a strong crack at keeping economic growth together”. But the “controllable” parts of the economy have shrunk in recent years while the more volatile and uncontrollable parts have expanded:
The combined headwinds of slowing exports, private investment and consumption will usually be much too strong in any regular capitalist economy and there is no evidence so far that China will be able to orchestrate something significantly different.
Among other estimates, CLSA says China’s 4Q08 GDP will slow to around 6.5-7 per cent YoY and early 2009 could hit as low as 4 per cent. The 5.5 per cent FY09 forecast “expects big ticket government projects to kick in”. There’s no official number yet for 2010 but CLSA predicts a mild recovery to the 7-7.5 per cent range.
Meanwhile, Tokyo-based analyst Peter Tasker sees some “eery” parallels between China’s jumbo fiscal package and Japan’s 1990s stimulus plans, which totalled Y100 trillion ($1,034bn), or 20 per cent of GDP. Japan’s attempt to bolster already-excessive levels of fixed asset investment failed. China must take radical measures to raise the consumption share of GDP or face a long and painful adjustment, he says.
A significance difference between the current credit disaster and Japan’s post-bubble slump is timescale. “Events are moving much faster today, both the wealth destruction and the policy response”.
But just like the recent Chinese package, there was a substantial difference in Japan’s 1990s plan between the eye-catching headline number and actual new spending (”real water”, in Japanese economic jargon), he notes.
The real water portion was usually less than half the total. The rest was window-dressing - loan guarantees, repackaging of previous spending commitments, loan guarantees for SMEs, larger loan quotas for public financial institutions, and pressure on private utilities to increase capex. Furthermore, the proportion actually spent tended to be even lower since it proved easier to announce giant infrastructure projects than to implement them
So was Japan’s Keynesian experiment useless? Not necessarily.
It is true that fiscal activism failed to generate a self-sustaining recovery, but in all likelihood the post-bubble recessions would have been much more severe if the government had sat on its hands. The stock market recognised this and rallied, often quite sharply, as the various fiscal packages were announced.
When the inevitable happened and Japan’s financial bubble burst, the authorities understood that a rapid deflation of the fixed asset investment bubble would risk a depression. Hence the strategy of replacing corporate capex with government-led big projects. Cuts in income and sales taxes, the obvious alternative, were shunned.
The result of attempting to shore up the fixed asset to GDP ratio at unsustainable bubble levels was to lower the economy’s long-term return on capital, damage the quality of the government’s own balance sheet (future pension/social security crisis), and insofar as the private sector banks were “encouraged” to make new loans to weak credits and delay the work-out of old loan, to contribute to the future banking crisis.
China at this point looks as though it’s following the same path, notes Tasker.
Household consumption, the least volatile component of the economy, is at an extraordinarily low level on any historical and international comparison. Exports and fixed asset investment, the most prone to intense boom and bust cycles, are at extraordinarily high levels.
“Like Japan’s policy-makers in the 1990s, Chinese policy-makers are probably aware that a rapid deflation of the fixed asset investment bubble would risk a depression. Thus, the fiscal package, which no doubt will be the first in a long line,” he says. Domestic consumption, however, is key. “Unless the economy’s low share of consumption is addressed with radical measures — and they would have to be radical given the starting point — the structural adjustment is merely being delayed.”
It is doubtful, though, whether the Chinese system could handle a “lost decade” with as good grace as Japan has, Tasker adds.
Merrill Lynch, meanwhile, says China’s investment plan “should not be under-estimated”. In a Monday note, Merrill’s metals and mining equity research analysts say the plan “illustrates the determination of China to maintain its strong growth trend”, and supports Merrill’s estimated 8.6% GDP growth forecast for China in 2009 - underpinning Merrill’s “broadly positive stance on the metals” sector.Regardless of the debate over how much of the Rmb4bn number had already been announced, Merrill makes three points:
The Rmb3.1bn [of already planned spending] is incremental to the existing five-year growth plan; the stimulus should contribute 3 per cent to GDP growth in 2009 and 2010; and while the spend accelerates immediately, the multiplier-effect from increased wages and confidence should kick-in later.
Morgan Stanley Asia, also, advises against attaching too much importance to the “incremental amount of investment reflected in the fiscal stimulus plan by comparing to the original investment plan under the 11th Five-year Plan”. In fact, to try to compare is “meaningless”, says MS’s China research team.
This is because the so-called five-plan is just an indicative reference and “by no means a hard target for either the investment amount or sectoral allocation”. In practice, “the actual investment execution is very different from the original five-year plan”.
At this juncture, debating whether the Rmb4tn package is incremental or how it is going to be funded is of second-order importance, despite that we have spent much time on this subject. The key is the government’s policy stance has shifted decisively toward pro-growth by adopting a campaign-style approach. It is clear that the authorities want to bring growth to a desired level with all means at their disposal. If this current policy package were to prove insufficient, we have no doubt it will be augmented.
The real question, according to MS Asia, is, what is the magic number - that is, the desired level of GDP growth for 2009.
We think growth of 8-9% is what the authorities really want to achieve, but if it were to turn out to be 7-8%, it would also be considered acceptable. So if one has strong conviction that the
market has priced in a too low growth scenario, then the market is underestimating the ultimate impact of the authorities’ policy response, in our view.
We recently downgraded our GDP growth forecast for 2009 from 8.2% to 7.5%, despite the announcement of this fiscal stimulus package… This is because we have already factored in the impact potential fiscal stimulus package. Without this stimulus package, the economy would likely head toward a hard landing (eg, 5%) in 2009. With this fiscal package, the risk of a hard landing scenario (ie, below 7% growth) has diminished substantially, in our view.
Even so, it concludes, the Chinese economy “will likely continue to decelerate over the next three quarters before bottoming out by mid-year 2009 and stage a modest recovery in 2H09, as external demand starts to improve and the effect of pro-growth policy kicks in”.
Finally, on the subject of fiscal stimulus and Japanese recession, we go to Lex’s view that fiscal stimuli in this day and age “require two things Japan appears to lack: money and good ideas”:
Japan is the most indebted rich country, and already committed to raising $260bn this year. As for viable proposals, a storm of protest forced the government to backtrack on its $21bn handout plans. Thank goodness: chances are most of the rebates would have been stuffed in banks rather than spent. The pity is that, with timid consumers and the broad measure of deflation used in GDP calculations running at 1.6 per cent year-on-year, protracted recession is just as likely in Japan as anywhere else.
Well, at this rate, possibly far more likely in Japan than in China.
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