In Full Flight

The Chinese economy is growing at a staggering rate, with the first quarter gross domestic product (GDP) increasing 11.1 percent and the According to statistics from the People's Bank of China, financial institutions loaned about 1.42 trillion yuan ($1=7.73 yuan) in the first quarter, up 13.4 percent compared with the same period last year.trade surplus soaring to $46.44 billion despite a sharp drop in March.

With the first quarter having drawn to an end, the world is left wondering how China has performed in, or rather endured, the three months following the end of its World Trade Organization (WTO) transitional period in December.

To provide a comprehensive overview of first-quarter economic performance, Beijing Review conducted an exclusive interview with Tao Dong, Chief Economist of Credit Suisse First Boston (CSFB), to get his insights into the Chinese economy.

Dealing with a muscular GDP

Tao revised CSFB's forecast for China's 2007 GDP growth up to 11 percent from his previous forecast of 10.4 percent, noting that the economy is reaccelerating and expecting rebounds in fixed asset investments. "This projection is made based on expected [government] restraints and tightening measures later this summer," said Tao.

The Chinese Government has been talking about an 8-percent GDP growth for four years now, but it never comes to fruition. The actual growth rate has exceeded 9 percent with ever-increasing speed year on year. Concerning China's economic performance over the next quarter, Tao said timing is the essence.

"The growth outlook for the second quarter this year depends on when and how Beijing launches the next round of tightening measures," he said. Tao expects two interest rate hikes (54 basic points), as well as another two of the reserve requirement ratio (100 basic points) in the coming months.

According to Tao, these rate hikes are only mild measures. He expects the tightening policy to escalate in mid-year, when the consumer price index (CPI) exceeds 3 percent, as the stock market becomes more speculative, and as bank deposits continue to flee amid negative interest rates. Tao said the ratio would have to jump to 11-11.5 percent in order for Chinese monetary policy to escape the liquidity trap.

Tao said, "We have also revised our year-average CPI forecast to 3.2 percent from 3 percent." But he added, "We assume the domestic A-share stock market and the (uncertainty of) U.S. housing sector are the two biggest risks to our growth forecast this year."

First quarter CPI surged to 2.7 percent, just as experts had predicted. In 2006, the average CPI grew a mild 1.5 percent compared with the 2005 rate. However, CPI growth has increased recently, up 1.9 percent since last November, with its largest surge of 2.8 percent last December.

Turning to 2007, CPI doesn't show signs of cooling down. It jumped 2.2 percent in January and 2.7 percent in February. Experts warn the rapid increase in CPI could possibly lead to inflation, though growth rates below 5 percent are tolerable.

Tao contended that the inflation pressure of the global economy will grow, and central banks of all countries will increase interest rates more often than what is widely suspected.

Investing in the infrastructure

Chu Jianfang, macroeconomy analyst with China Securities Research Co. Ltd., said that at present, a 23-percent or even possibly a 25-percent growth in fixed asset investment is reasonable, arguing that China is a big country and that dedication to infrastructure is for the benefit of the people.

Growing investment has triggered rapid bank loan increases. According to statistics from the People's Bank of China, financial institutions loaned about 1.42 trillion yuan ($1=7.73 yuan) in the first quarter, up 13.4 percent compared with the same period last year. While banks increased their loan-giving pace, deposit growth rate slowed in the first quarter.

"As a matter of fact, China is undergoing negative interest rates," said Tao. "The bank deposits have constantly flown out of the banks and into the stock market and the real estate market." Currently, it is widely believed that investing in the stock market and the property market will bring more profit than waiting on bank interest, despite potential risks in the two markets.

Due to this, Tao assumed that the property market will be hot as even, but this projection is subject to policy changes. Statistics from China Securities Depository and Clearing Corp. Ltd. show that by the end of April 13, total accounts in the Shanghai and Shenzhen stock markets had reached 89.2407 million, with 140,000 new accounts being opened each day.

In the first quarter, over 5.01 million new accounts were opened in China's stock markets. New accounts for all of last year were a mere 3.0835 million.

Structural surplus and foreign trade

Trade frictions with China's major trading partners will be inevitable if the trade surplus continues to be this high. To ease these trading partners' concerns, Tao argues that they need to be aware of the structural dilemmas China faces.

"First of all, I think a lot of trade surplus is structural," Tao said. "China has evolved into a world factory, and a bulk of production capacity has been allocated to China, so that it is unavoidable that China will have a large surplus which would not be affected by regulative measures."

Tao explained that an increasing amount of production has moved to emerging markets like China and India. China is a major goods provider, but not a service provider, which is why there is a huge surplus in China's current account, he said.

Tao pointed out that all forward-looking indicators in March-new orders, new export orders, import index and backlog of orders-saw increases of about 4 percentage points from the previous month, the strongest jump since 2005. The relatively late occurrence of the Chinese Lunar New Year (falling in mid-February this year instead of late January) probably added a little upward bias to the March data, he said. "But by all means, this set of data is strong, indicating that economic activities are likely to accelerate further from the robust figures recorded in the first two months of this year," Tao argued.

Adding the renminbi (RMB) appreciation factor, Tao believes China's imports will also boom. Tao projected that the RMB and dollar exchange rate will probably stand at 7.33 with the Chinese currency continuing to appreciate to 6.9 in exchange with the dollar.
Loan growth, inflation, speculation worries

To achieve "sound and fast" economic development is a target set in the 2006 government work report. However, real actions won't come as easily as words. Tao discussed three major problems that should be carefully watched by the government authorities.

First of all, bank loan growth is too fast, said Tao. Rapid loan growth helps fuel excessive liquidity, which holds hidden troubles for China's financial and capital markets. Excessive liquidity can cause rampant price fluctuations and market bubbles. If excessive liquidity is suddenly squeezed out, the stock market will be hit and the overall economy will suffer, he said.

"We expect the lending behavior of Chinese banks to change," Tao said, adding that the recent loan boom doesn't jive with the long-term objective of bank reform in China.

Secondly, Tao fears possible inflation if the CPI keeps climbing over the warning limit. "It is rebounding and is likely to exceed 3 percent by the middle of this year," Tao estimated. At present, not only is fiscal inflation picking up steam, but also asset inflation is growing even faster. "We actually see the bank depository rate heading into negative, which prompts the banks to look for higher investment opportunities," said Tao.

Tao also worries that increasing speculation in the Chinese stock market will generate more bubbles. The Chinese stock is traded two times more in price/earnings ratio than the global average of 17 times. This distortion is likely triggered by speculative capital. Tao argues that if the stock market is not handled properly, it can harm China's economic stability.

But luckily, the decision-makers have already attached due importance to speculation, and the government is expected to attempt to squeeze out the speculative bubble in the stock market.

"Overall, I think a mild wave of austerity programs are likely to be launched," said Tao. "We've already seen interest rates and the reserve requirement ratio raised. We expect more to happen."