Are concerns about a Chinese economic bubble overstated?

Questions are being asked about the sustainability of China’s economic growth, but Jonathan Wu argues that the positive growth story remains more substance than bubble.

China defied many of the sceptics when it achieved gross domestic product (GDP) growth of 8.7 per cent early last year, but questions continue to be asked — both inside and outside of Beijing — about whether the growth is genuine and sustainable or just a Government-induced bubble.

Our belief at Premium is that what is happening in China is not a bubble — notwithstanding perceived parallels with past events in Japan and elsewhere.

Many are comparing the unprecedented lending and increase in house prices in China over the last 18 months to the real estate bubble in Japan in the late 1980s.

There are several common (and uncommon) themes here. Firstly, Japan was in a boom period with strong growth in the early 1980s — just as China is now.

Property prices were escalating in Japan, and an inflexion point occurred in 1985 when the downturn of the Japanese economy began as the yen started to appreciate.

This forced the hand of the Bank of Japan to ease monetary policy in an attempt to boost demand, which led to a liquidity surplus.

As a consequence, this liquidity flowed straight into equities and the commercial property market.

By many accounts, at the market’s peak in 1990 the market value of the Japanese emperor’s palace could have bought all of California.

Nevertheless, Japan was growing strongly until 1985 (but only achieved 3 per cent GDP growth after that) when monetary policy was enacted. In stark contrast, China’s lending during 2009 led to stronger growth than the year before, achieving its golden ‘8 per cent plus’ target.

Another theme that needs to be discussed is the level of borrowing for property compared to deposits.

In China, over 50 per cent of the properties sold are purchased without the need for borrowing.

Compare this to the US, where homes were used as glorified ATMs and money was loosely handed out via the infamous NINJA (no income, no job or assets) loans.

This is in stark contrast with China, where foreclosures are low because properties are lowly leveraged.

The so-called ‘lending bubble’ in China has led to an increase in loan to deposit ratios from 63 per cent to 70 per cent over the 12 months ending December 2009. When you contrast this with Australia’s 126 per cent loan to deposit ratio, the Chinese banking sector is in conservative hands.

This was why the Asian banking system came out of the GFC in such strong shape. The banks learnt their lessons about high leverage during the Asian financial crisis of 1997-98.

When you compare China’s ‘boom’ between 2003-2009 and Japan’s boom and bust of 1985-1991, you can see that property growth rates in China are in line with a high-growth economy.

Compare this to the low-growth Japanese economy that had very strong property price hikes that didn’t make fundamental economic sense.

You must also separate the first-tier Chinese cities (eg, Beijing, Shanghai, Shenzhen) from the second and third-tier inland cities (eg, Xian, Shandong, ChongQing) that haven’t been the subject of a ‘boom’ just yet.

Certainly, Beijing and Shanghai have become unaffordable, but these two cities only make up a population of approximately 30 million — compared to the other 1.27 billion people in the rest of China.

There are over 100 other cities in the country that have populations of over 1 million people and are undergoing urbanisation and modernisation processes. Their property markets are only starting to develop and affordability in many of these places is high.

Now, lets discuss the apparent lack of a bubble in the general Chinese economy.

Transition to consumption economy seems strong

Chinese consumers will be able to take over from US consumers, but this will be a slow process over the next 20 years.

Retail sales remained strong during the GFC, with their lowest point being 11 per cent year-on-year growth in late 2008. This figure has consistently held above 15 per cent since late 2009.

Consumers in China are becoming savvier and are demanding higher quality goods. While foreigners in China tend to look for imitation goods, Chinese citizens want the real thing. This shows the new mindset of the Chinese population.

Increasing population in secondary and services sectors

With the land reform program starting to unfold in the rural parts of the economy, many farm residents will start to look for better opportunities in the cities for themselves and their families.

With this transition, the percentage of the population moving to the secondary and services sectors will boost GDP.

This will not prove to be a bubble, but more of a natural phase in a developing economy.

This process of transition has been seen before (eg, when the US took over from the UK as the world leading economy in the 1920s) and once again we will see it happen again.

Private economy taking over the reigns of stimulus

As has been discussed in Premium roadshows beginning in 2009, government stimulus packages across the globe should only focus on one thing.

How do their respective packages encourage private businesses to take over the reigns of economic growth after government stimulus ends?

As we can all appreciate now, governments cannot simply keep printing money to stimulate the economy.

As infrastructure projects got underway in China (and across Asia), private non-government related investment also increased — a pleasing sign.

By October 2009, growth of the non-government sector had outstripped government spending growth. This is the ultimate aim of stimulus, and has been subsequently achieved.

We look forward to seeing how 2010 will play out for China.

It certainly has its challenges. Government monetary policy is targeting overheating parts of the property market in first-tier cities, and we will closely observe the situation there.

The measures to be implemented must ensure the longevity of the economic recovery and the long-term stability of 8-9 per cent growth.

Chinese growth over 11-12 per cent has now been established to be unsustainable and the government has acknowledged that.

It will now aim to slow down the economy to ensure bottlenecks are fixed before they have serious consequences. It will also put infrastructure in place that will modernise the Chinese economy.

Our ultimate message is that any developing economy will have its challenges and cycles, but when you draw a line of best fit — whether it be GDP growth, stock markets or productivity/efficiency — emerging markets, and especially Asia and China, have outperformed their western counterparts over the long term.

Jonathan Wu is head of distribution and operations at Premium China Funds Management.