A Quick Turnaround

The 8.7% year-on-year (y/y) growth for 2009, the slowest since 2001, represented a 4.3-percentage-point fall from the recent-year high of 13% in 2007. Nevertheless, the pace of growth has exceeded the 8% target set by the central government for this year, and was far above the 7.8% y/y growth recorded in 1998, the nadir of the Asian Financial Crisis.

The Chinese economy rapidly descended into a downturn since the final quarter of 2008 with the onset of the most severe exports slump in three decades, with GDP growth slowing to a record low of 6.1% y/y in the first quarter of 2009. Nevertheless, the economy has staged a dramatic V-shaped recovery since the second quarter of 2009, on the back of strong fiscal stimuli from the four-trillion-yuan (US$586-billion) stimulus package and an ultra-easy monetary policy. GDP growth rebounded to 7.9% y/y in the second quarter, further accelerating to 9.1% y/y in the third and to 10.7% y/y in the fourth quarter, according to the National Bureau of Statistics (NBS).

The industrial sector, the main underpinning of the Chinese economy, has seen an even more dramatic turnaround, with growth bouncing from only 5.1% y/y in the first quarter to 9.1% y/y in the second quarter, 12.5% in the third and further to 18.0% y/y in the fourth quarter, bringing the whole-year industrial added value growth to 11.0% y/y—a modest fall of 1.9 percentage points from 2008. Leading the industrial growth was the heavy industrial sector—a segment that has benefited most from the stimulus package, which recorded 11.5% y/y growth in 2009, while the more export-oriented light industry registered a slower growth rate, at 9.7% y/y.

A Recovery Driven by Government Stimulus

Last year's recovery was entirely led by domestic demand, most notably government-led investment. Fixed-asset investment (FAI), which expanded 30.1% y/y last year, accelerated from 25.5% y/y growth in 2008, led by a surge in government-led infrastructure investment. Total investment for infrastructure, excluding power, amounted to 4.19 trillion yuan—18.6% of total FAI—which marked a y/y increase of 44.3%. Real estate investment, the main segment of private investment, hit 3.6 trillion yuan—a rise of 16.1% y/y—which, although 4.8 percentage points slower than in 2008, also marked a turnaround from only 4.1% y/y growth posted in the first quarter. In the meantime, retail sales, a rough proxy of private consumption, increased at a rather robust pace of 15.5% y/y in nominal terms and 16.9% y/y in real terms—2.1 percentage points faster than 2008, providing another underpinning for overall economic recovery.

The external sector's contribution to China's growth was negative last year, as exports fell 16% y/y and imports declined 11.2% y/y—resulting in US$196.1 billion in trade surplus, a plunge of 34.2% y/y. Encouragingly, the exports sector already bottomed out at the end of last year, with exports returning to positive growth in December 2009 with a 17.7% y/y increase—ending 13 straight months of decline. Still, the country's more rapid recovery relative to the global economy also means faster growth of imports in relation to exports, which will constrain the improvement in overall trade balance.

Prices Start Catching Up with Growth

Despite the strong upturn of the Chinese economy over the past year, the whole-year price levels in the country still stayed in the deflationary zone in 2009, with the consumer price index (CPI) falling 0.7% y/y and the producer price index (PPI) declining 5.4% y/y. Nevertheless, both consumer and producer prices have crawled out of the deflationary zone in the final two months of last year, offering early signs that goods prices are starting to catch up with growth. CPI returned to a marginal positive growth of 0.6% y/y in November before accelerating to a growth of 1.9% y/y in December, pulled by a 5.4% y/y rise in food prices, while PPI growth climbed back to positive for the first time in December, coming in at 1.7% y/y.

Asset prices, on the other hand, have already run wild, as the massive liquidity injection has fuelled a huge asset market bubble even larger than that in 2007. The average selling prices index of common buildings in the country already gained about 10 percentage points by November last year, from its trough in February, according to data from the national statistics authority. The index, now at 115, is the highest since 1998, when the series started. The real estate bubble has been simply a manifestation of the liquidity bubble in China, as M2—the broad money supply—soared 27.7% on the year in 2009, accelerating by 9.9 percentage points from growth recorded in the previous year. As a result, M2 as a share of China's GDP last year amounted to 181%, and the loans-to-GDP ratio hit 119, record highs over the past decade.

Outlook and Implications

The 2009 GDP data show that the massive government stimulus has been effective in staving off the worst external-demand recession China has seen since reform began in 1978. The effectiveness of the investment-focused stimulus is mainly attributed to the great speed and volume with which the government has been able to inject investment spending into the economy. Furthermore, the stimulus spending has been extremely domestically oriented, with very little leakage to imports. Until the last two months of 2009, the 30%-plus increase in investment spending has not helped lift imports, as the monthly import growth stayed in the negative double-digit territory for most of 2009.

The ultra aggressive stimulus plan is a short-term emergency measure that cannot be sustained without generating distortions such as an asset market bubble. Concerns about asset price inflation, combined with the recent uptick in goods prices and the final turnaround of the exports sector, have prompted a gradual macro policy shift towards the inflation end of the growth-inflation balance. The recent tightening moves of the Chinese central bank are therefore not all too surprising. In tandem, the Chinese government is also likely to adjust its renminbi policy by allowing the currency to resume appreciation against the U.S. dollar, although in a limited way at the start, after holding the exchange rate steady since the end of 2008 as part of the stimulus policy package. Nevertheless, aggressive policy tightening at this point is still unlikely. Given organic recovery—non-stimulus related growth—is still in the nascent stages, the government will move gradually in shifting the growth-inflation policy balance.

Given the strong momentum of investment growth and the rebound in exports, the strength of China's growth through 2010 should be secure. Beyond 2010, however, given the developed economies are unlikely to grow strongly, in addition to the Chinese government's expected further pullback on stimulus, China's growth is likely to moderately decelerate. As such, IHS Global Insight expects China's growth to accelerate to 9.9% y/y in 2010, before pulling back to 8.6% y/y in 2011.

Global Insight (Reino Unido)