Will Consumers Follow Investment's Lead?

飞雪寒冰

China's economy appears to be warming as a chief growth engine – investment -- offsets the negative impact of sluggish external demand.

But how long will the warm spell last? When positive effects of the government's massive stimulus investment start to fade, and overcapacity and inflation creep back, will China's economy cool again? Or can a rising consumer sector keep the home fires burning?

Local infrastructure has been the first sector to benefit from the 4 trillion yuan stimulus package enacted last fall. In May, urban fixed asset investment grew 38.6 percent compared with the same month last year. Coupled with a producer price index decrease of 7.2 percent that month, real growth of fixed assets rose 45.8 percent – the highest since January 1998.

Some industries are basking in newly invested capital. Investment in rail transportation, for example, grew 110.9 percent in the first five months of this year. Investments rose 16.1 percent in the electric power industry.

Private investment growth in May returned to pre-financial crisis levels, mainly due to the stimulus spillover effect, rather than improved demand, said Caijing chief economist Shen Minggao.

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The money spilling over into industries upstream and downstream of those directly related to infrastructure investments not only helped cash-strained private enterprises but also encouraged more private investment.

Investments by domestic, private enterprises grew 40.6 percent year-on-year in May, while investments by enterprises based in Hong Kong, Macau, Taiwan and overseas grew 5.3 percent. But Shen is not sure the trend can continue.

"A sustained rebound in private investment remains a big uncertainty," Shen said, citing a need for private funds to step in and replace the blast of government spending in order for the country to get on the road to economic recovery.

Mu Hong, vice director of the National Development and Reform Commission (NDRC), said at a June 11 conference that the government will launch policies to encourage and guide more private investment as soon as possible. And Wang Xiaoguang, who heads an NDRC think tank, said these new policies would facilitate long-term structural adjustments, even though any significant lift for private investment would be difficult in the short term.

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Wanted: Consumers

Yet many economists argue that long-term growth in China will not be sustainable without a strong consumer sector. And according to Wang, weak consumption is currently choking China's economic growth. In terms of its contribution to GDP, China's consumer sector is still under construction.

"Growth in actual consumption, which usually lag behind GDP adjustments, has yet to emerge, and will not likely come about until the second half of this year, or next year," Wang said.

Wang said effective government measures could trigger a turnaround for consumption, but Shen said policies aimed at stimulating domestic consumption would take time.

Domestic consumption is needed along with investment because a strong rebound in China's export industry is unlikely in the second half of this year. And sustaining the government's current investment level would be difficult over the long term.

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As of May 31, the central government had invested 908 billion yuan, or 60 percent of its scheduled contribution to the stimulus package. Local governments are matching Beijing's spending to bring total investment to 4 trillion yuan.

According to a forecast by Central Huijin, a state-owned investment vehicle, the central government may have distributed all stimulus funds by the end of the third quarter. This forecast was based on current rates of disbursement.

Wang predicts that economic growth will start to weaken again by the end of the fourth quarter as the impact of stimulus spending starts to wear off.

New government bond issues could raise more funds for spending projects, although Liu Shangxi, deputy director of the Research Institute for Fiscal Science at the Ministry of Finance, said the earliest date for a fresh round of bond sales could be toward the end of the year, even if the economy weakens again in a so-called “W-shaped” recovery pattern.

Liu has recommended that government fiscal policy in the second half of the year focus on implementing current measures.

Ha Jiming, chief economist at China International Capital Corp., predicted government fiscal and monetary polices won't change significantly until its targeted 8 percent annual GDP growth rate this year is secure.

But Ha worries that the market may question the sustainability of mid- to long-term fiscal policies if the central government decides to strengthen its stimulus effort.

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Inflation Clouds

Meanwhile, any celebrating over an apparent economic recovery is being overshadowed by looming inflation risks. Some economists are already sounding an alarm.

On the surface, inflation appears to be under control. China's consumer price index fell 1.4 percent in May. It was the first time CPI had fallen for four consecutive months since the economy completely recovered from the Asian financial crisis in 2003.

But Song Qingguo, a professor at Peking University's China Center for Economic Research and an adviser for Goldman Sachs Gao Hua Securities, said CPI actually rose 2 percent in May on a seasonally adjusted basis. He said the more upbeat figure was based on data released by the National Statistics Bureau that did not account for seasonal effects.

Inflation fears were reinforced by a recent rebound in commodity prices and international efforts to inject liquidity into the market.

Indeed, Ha said the economy has already experienced significant inflationary pressure. He thinks inflation will arrive earlier in China than in the United States, with domestic CPI turning positive in November and rising between 3.5 and 5 percent in 2010 – above estimates that the U.S. inflation rate will climb between 0.5 and 1.3 percent.

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China's investment-driven growth is more susceptible to fluctuations in global commodity prices, Ha added. And it's difficult to estimate future inflation because food accounts for a large portion of the basket of goods used to calculate CPI in China; agricultural products are particularly vulnerable to supply side shock.

Zhu Jianfang, chief macroeconomic analyst at Citic Securities, said prices are likely to bottom out in the third quarter of this year before starting to rise again in the fourth quarter.

But inflationary pressure is unlikely to emerge this year, Zhu said, as at least 12 months will be needed for the global economy to recover and resume the kinds of growth seen between 2002 and '07.

Caijing's Shen said that, despite expectations of higher inflation, China is unlikely to feel the effects of serious price increases this year. One reason is that no one knows how much of the money borrowed from banks in a massive lending surge since January actually landed in the real economy.