The Future of China's Stimulus Efforts

To what extent is the Chinese government winding down its stimulus spending?


The Chinese economy has so far this year given investors plenty of reasons to be spooked. For starters, there have been concerns that a tightened lending environment means that the Chinese government is winding down its massive stimulus package. Meanwhile, the Shanghai Composite Index, which is the most common way to track the performance of the Chinese stock market, has tumbled by around 8.8 percent year-to-date.

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Then there's the spat between President Barack Obama and the Chinese government over whether Beijing is artificially depressing the value of the yuan in order to prop up Chinese exports. And let's not forget about the Google fiasco and the uncertainty about whether the search engine giant will abandon its position in China. If it does, it would virtually guarantee a monopoly for the Chinese company Baidu, which already has the dominant share in the country's Internet-search market. 

U.S. News recently spoke with Edmund Harriss, a comanager of the Guinness Atkinson China and Hong Kong fund, about this confluence of events. Excerpts: 

To what extent is the Chinese government unwinding its stimulus efforts?

I would put it as sort of adjusting rather than unwinding. I think unwinding is probably a bit strong. They are still proposing to allow new loans of about $7.5 trillion [yuan] to go into the economy [this] year. That is certainly lower than the $9.5 trillion that came in during 2009, but is still very good growth. … What they are a bit concerned about is the pace of lending that was achieved in 2009, were that to be replicated in 2010, would in their view lead to issues related to too much liquidity, asset-price inflation, wasteful allocation of capital. … And so what they're trying to do is just apply some brakes to that new lending. We got off to a racing start in the first two weeks of January, which was looking like a rerun of 2009, and the central bank … applied the brakes. But it is noticeable that China is not unwinding its stimulus package inasmuch as those incentives for consumers—such as to buy cars or to buy consumer durables or for people buying their first homes—all of those incentives are still in place. … The way I read it, the Chinese know that the economy still needs support, that the individual consumer needs more support, but [think] that in areas—particularly … where there is already plenty of cash and where that's starting to turn into speculation—they can have some of these incentives withdrawn. And that's what I see going on. 

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And you think that this pattern will hold true throughout 2010?

Yes, I do. I think that there's certainly no appetite to put growth at risk. The fundamental issue—why China put in the stimulus package in the first place—is that they need the kind of growth that creates jobs. And for job creation to continue, they clearly need to sustain growth in the big employers—and that means basically heavy industry and construction, because that's where you're going to get the income growth. And they [also need] to try to unlock some of the household savings that have built up in recent years as individuals have increased their precautionary savings to deal with unexpected items like hospital treatment. So they're trying to tailor policies to keep private consumption moving as well as to keep job creation on track. And I think it's just the case that when they really threw everything at the economy to get it moving, that has done its work. Now is the time to take some of that froth off. But it's a problem really that's going to be faced by all governments, which is sort of how to withdraw the stimulus without triggering the very thing that you've sought to avoid. But China has achieved such extraordinary domestic growth in the past year that they can afford to move earlier. But it is not a clampdown in my view. What I think we're going to get, though, is there is always uncertainty when policy changes or when there are adjustments to policy, and I think it's going to be a little stop-start as expectations both inside China and outside China adjust to the idea that it's not a free-for-all ad infinitum. 

Does any of this give investors a good reason to re-evaluate their positions in China?

No, I don't think it does. I think what it does is that it should encourage investors to view the Chinese growth story as one that can be sustained. Whereas I think if they weren't making the changes that they are now, there would be every prospect that 2011 would see a bust, would see a painful drop in the rate of growth as China really did have to apply the brakes hard. I think they've moved a lot earlier than folks were expecting by moving in the middle of January rather than waiting for, say, the second quarter of the year. Chinese policymakers have proved in the past to be quite quick to move to try to head off the kind of excesses or bubbles that we've seen in China's economic past. 

Is China depressing the value of its currency?

I think that China's currency is probably too low. I think there has definitely been a sense, particularly among a certain section of exporters where margins are incredibly thin, that any move in the currency will basically wipe out what little margins are left. When you think about the kinds of products that Wal-Mart is buying from China—sort of low-end textiles or plastic toys—they really drive down margins incredibly low. But I think there is also sort of a sense that a more expensive currency would be to China's benefit. And I think that there is a recognition of that fact inside of China, too. [I think they feel] that there are certain types of export business that they don't really want because they're low-value-added activities that use up quite a bit of resources—whether it's in terms of the energy that's used to drive the machinery or whether it's the labor that could be better employed elsewhere. So these are not the types of industries that they want. And secondly, a more valuable currency could act as a counter to inflationary pressures that we expect to materialize over the coming year. So I think we're going to see some move on the currency this year. 

What are your thoughts about Google's talk of pulling out of China?

It's very early to say how it's going to play out, because Google has not pulled out of China. There was plenty of noise, and then it's been pretty silent. And presumably there are talks proceeding behind closed doors now as Google and the Chinese authorities try to reach some accommodation. Because it wasn't going well; certainly there was a lot of bluster going on from Chinese authorities about "Google must toe the line, they must follow the rules that China sets." I don't think that those words were said with a huge degree of confidence. So for the present, I think Baidu's market share will continue to grow, but quite where it leads Google and quite how they plan to play things in China going forward, I'm just not sure.