World is dancing to a Chinese tune

By James Kynge

Financial Times

Published: December 31 2004

The last 25 years have traced the changes wrought in China by its growing openness to the world. But 2004 signalled the start of something new; it served notice that the future may be involved less with how the world is changing China than how China is changing the world.

Three years after its entry into the World Trade Organisation, China’s influence in global commerce is no longer merely significant. It is crucial. In some international markets, such as those for most base metals, shipping, coking coal, soybeans and other agricultural commodities, Chinese demand has become either the dominant price-setter or a big swing factor.

With gross domestic product expanding at an official 9.5 per cent in the first three quarters of 2004, China was also the main driver of Asian growth - as crucial to Japan’s recovery as to Malaysian growth. “Now everything is made in China,” says Noriko Hama, professor at Doshisha University in Kyoto, Japan. “Include (in that) Japan’s economic cycle.”

But the pull of the Middle Kingdom’s economic gravity has not been uniformly benign. While Brazil, Argentina and Australia celebrated China’s huge appetite for resources, US fears over American manufacturing jobs migrating to the Pearl and Yangtze river deltas was a source of rancour during the presidential election campaign.

In Europe, which surpassed the US as China’s biggest trade partner this year, cheap Chinese shoes were incinerated by Spanish competitors and anti-dumping cases lodged against mainland companies remained at a high level. Industrialists and politicians questioned whether restrictive European labour laws left their companies at the mercy of Chinese counterparts operating at one-tenth of their costs.

But while the world reverberated with a vast and newly-felt presence, a debate intensified within China on the extent to which the construction boom feeding its insatiable appetite was sustainable. Long-term, the need for infrastructure, factories and housing is clear. Three hundred million residents of rural China are expected to move to towns and cities by 2020, according to a government estimate.

The migration of foreign manufacturing capacity to China continues apace; foreign direct investment was nearly $54bn in the first 10 months - on course for a full year record. Roads, ports and railways are being built all over the country, creating markets where none previously existed - much in the same way that canals and railroads opened up the American mid-west in the 19th century.

But just as 19th century America was characterised by serial boom-to-bust cycles, so sceptics argue that China’s current boom has been built on an irrational exuberance. Others disagree, pointing to vast pent up demand in a country of 1.3bn people, relatively low levels of personal debt, and the dynamism of an underground economy invisible to the state’s statisticians.

The debate became polarised between those who felt that China’s economy was overheated and was therefore headed toward a “hard landing”, those who felt it was partially overheated but would manage a “soft landing” and those who insisted that near 10 per cent growth rates were healthy and there would be “no landing”.

The People’s Bank of China, the central bank, eschewed such terminology but seemed to occupy the middle ground.

Concerned that negative real deposit rates were helping to inflate investment in property and other fixed assets to unsustainable levels, the bank raised interest rates in October for the first time in nine years.

But by mid-November, officials said the level of fixed asset investment (FAI), which in 2003 contributed 47 per cent of gross domestic product, needed to be further reined in.

Li Ruogu, deputy PBoC governor, says the third quarter FAI growth of 29 per cent was still too fast, even though it had come down from above 40 per cent in the first quarter. “Thirty per cent (FAI growth) may be too high,” Mr Li told the Financial Times.

“You have to compare the investment. This year’s 30 per cent is on top of the base of last year which was already very high. So I think we would rather see a more sustainable rate of maybe around 20 per cent.”

He says the central bank is watching to see whether interest rates will have to be raised again but adds that the PBoC is “happy” to see a recent return to moderate M2 money supply growth. M2, the broad measure of money supply, grew 13.5 per cent in October compared to a year earlier - the slowest growth in three years and significantly off China’s full-year target of about 17 per cent. In addition, Mr Li says the central bank has been encouraged by a moderation in inflationary pressures in October, compared to the previous month, and predicts that the consumer price index for all of 2004 will show a manageable 4.1 per cent rise.

Such statistics suggest that China may be on course for a landing of featherdown softness in 2005. But several pressures could conspire to upset the economy’s poise.

Shortages of power, coal and transport capacity are raising the prices of industrial inputs, thereby squeezing the margins of manufacturers reluctant to raise product prices because of widespread oversupply. If profits - which are also being hit by the high international price of oil - decline significantly across the board, then the appetite for capacity expansions could wane - reducing China’s investment on fixed assets and diminishing demand for imports, a large portion of which are capital goods bound for factories.

China’s weight in world trade is such now that, even a modest drop in investment growth could have a palpable impact on global demand. This year, China is expected to eclipse Japan in terms of trade volume and become the world’s third largest trading nation behind only the US and Germany. In the first 10 months of the year, trade volumes rose 35.8 per cent to a total $926.47bn and, although import growth slightly outpaced exports, the country recorded a small trade surplus of $10.97bn in the first 10 months.

Trade experts say it is unlikely that such high growth rates will continue in 2005. Yu Yongding, senior fellow at the Chinese Academy of Social Sciences, has expressed misgivings over China’s increasing reliance on trade and foreign investment, noting that total trade volume now accounts for about 60 per cent of gross domestic product. He says that preferential policies extended to foreign enterprises over their local counterparts should be scrapped.

Nevertheless, China’s burgeoning trade relations have become a key preoccupation in foreign policy. Hu Jintao, president and Communist party boss, has expended considerable effort deploying diplomacy to shore up the supply of resources to feed the engines of China’s transformation.

Historically, great powers have tried to ensure security of supply with military prowess. But China lacks a blue sea navy and is unable as yet to project sustainably the power of the People’s Liberation Army beyond Taiwan, an island state off the south-east coast that Beijing regards as a breakaway part of its territory.

With its military limitations and careful of its international image, Beijing launched this year a strategy of “peaceful rise” as a new cornerstone in foreign policy. The essence of the strategy is to convince the world that China’s ascent does not threaten peace and then to cement trade ties, treaties and investments. Such a strategy is already showing progress.

Brazil, with which China exchanged presidential visits in 2004, is enthusiastically pursuing a bilateral “strategic partnership” that Beijing hopes will facilitate multi-billion dollar investments by Chinese corporations in the country’s iron ore, transport and alumina sectors.

In Africa, also visited by Mr Hu this year, China has a number of growing interests and pledged at a recent summit in Addis Ababa to boost two-way trade to $30bn by 2005 from $12.4bn in 2002. Beijing is also negotiating or hoping to negotiate trade agreements with Australia and south-east Asian countries. But while trade interests are extending China’s global reach, they also cause problems. Relations with the US have been officially better during 2004 than for many years as Washington looked to Beijing to attempt to resolve the nuclear crisis in North Korea and perennial tension over the issue of Taiwan were damped somewhat by conciliatory words from the administration of President George W. Bush.

However, Washington’s repeated entreaties to Beijing to allow the renminbi, China’s currency, to float have not had their intended response. Mr Li at PBoC says the US should recognise that its problems do not stem from an undervalued Chinese currency but from an unsustainably large trade deficit and a domestic savings rate of only about 2 per cent.

“China’s custom is that we never blame others for our own problem,” says Mr Li.

“For the past 26 years, we never put pressure or problems on to the world. The US has the reverse attitude; whenever they have a problem, they blame others.”