The coming China crisis

Warnings about trouble in the Chinese economy are getting louder and louder. The Chinese economy has been running white hot over the last 35 years after it was freed from being a controlled economy. Now it has the look of a jet flying with a dangerously overheated engine. It has been making several attempts to make a so-called soft landing, but it should be worrying about a crash. Risk and dangers from China could spill over and develop into a major crisis for the Korean economy. We must be vigilant - and prepared.

China’s economy grew at 7.4 percent last year, the slowest since 1990. The cooling of the real estate market and corporate investment amid excess manufacturing led to the slowdown. Pundits believe the Chinese economy could have underperformed the official data.

The news got worse in January. Exports fell 3.3 percent in January from the same month a year earlier. Imports plunged 20 percent year on year. The Purchasing Managers’ Index in January stayed under the 50.0 level that separates growth from contraction. The International Monetary Fund downgraded its growth outlook for China to 6.8 percent from an earlier 7.1 percent. Some people are already issuing deflation warnings. The consumer price index rose 0.8 percent in January. The product price index has been contracting due to excess capacity.

Side effects from fast growth are everywhere. Over-investment has weighed down productivity for some time and the number of companies teetering on the brink of bankruptcy is rising sharply. Local governments are running out of money as their primary income from properties has deteriorated due to a fall in real estate prices. Danger of a financial crisis looms as local governments and many enterprises have been borrowing recklessly from the shadow financial sector, which is beyond state supervision and regulation.

The Beijing government has been carrying out structural reforms to raise the quality of growth. In an address at the World Economic Forum in Davos, Switzerland, Chinese Prime Minister Li Keqiang said China has entered a state of “new normal” with the economy growing in the medium range instead of at high-speed. Instead of short-term stimuli measures, the Chinese economy will run on steady growth backed by structural reforms. Beijing is expected to keep up with a flexible fiscal and monetary policy mix to preempt a hard landing or sharp slowdown and sustain the economy while reforms are underway. The Chinese central bank lowered the reserve requirement ratio for institutions to pump up liquidity as weakening accelerates from manufacturing activity to trade data amid low inflation and signs of flight from foreign funds.

As long as authorities keep a close watch, a major crisis can be kept at bay. But whether they can navigate the economy to land softly remains uncertain. They may lose control if downward pressure from the massive debt and financial risks build up. Local governments told by the state to reduce the regional development gap cannot achieve the task without ruining their fiscal integrity. The structural shift from an economy more oriented towards domestic economy and services can be very disruptive, especially the process of privatizing state companies and financial institutions. The economy could slip below the growth rate of 5 percent. Any fiscal or financial crisis would cut further into growth.

Deterioration in the Chinese economy would deal a major blow to the Korean economy. Exports to China take up one-fourth of Korea’s external trade. China is also a pivotal revenue base for Korea’s financial and tourism sectors. Chinese tourists are the biggest foreign customers for Korean retailers. The IMF’s chief economist, Olivier Blanchard, warned that a slowdown in China could pose a serious threat to Asian economies like Korea that rely heavily on China. Korean exporters will further struggle if Chinese manufacturers begin dumping their inventories on oversea markets to ease their supply glut.

Korean authorities must closely examine weaknesses in the local economy to brace for fast cooling in the Chinese economy. Responsive macroeconomic and foreign exchange policies are important. More attention should be given to the vulnerabilities of large consumer and corporate debt. Companies doing business in China must draw up contingency plans. Traditional mainstream exports in semiconductors, steel, shipping, petrochemicals and automobiles won’t be able to maintain their competitiveness for long. Large companies will have to turn to more innovative technology and manufacturing to weather the challenging times.

The engines driving the economy must be diversified. The economy is over-reliant on exports and manufacturing. Exports, which accounted for 34 percent of gross domestic product in 2002, now make up 56 percent. Labor productivity in the services sector remains just 40 percent of the manufacturing sector. The economy must run on a balanced engine of external trade and domestic demand backed by the services sector.

Yellow sand from China has recently irritated us greatly. We also should be alert to the economic risks stemming from China. We must prepare ourselves so that the ill effects do not harm us.

Translation by the Korea JoongAng Daily staff.

JoongAng Ilbo, Feb. 27, Page 31

*The author is an economics professor of Korea University.

by Lee Jong-hwa