This news is a few days old, but worth noting in advance of next week's meeting of G-7 finance ministers, which will reportedly include some discussion of what the Chinese central bank should do about the yuan. From The Economist:
ON TUESDAY January 25th, the Chinese authorities sheepishly confessed that the economy beat expectations last year, growing by 9.5%. It finished the year particularly strongly, growing at an annual pace of almost 13% in the last three months, according to J.P. Morgan. Anywhere else, this would be cause for celebration. But in China, the firecrackers remain unlit. Instead, analysts and investors are trying to reassure themselves that this is not bad news.
Why would this be bad news?
But economists are anxious about the balance of China’s economy as much as its speed. China may or may not be growing too fast, but it is certainly investing too much. In the year to the first quarter of 2004, spending on fixed assets—plant, property and infrastructure—grew by 43%. Investment accounted for 42% of GDP in 2003, and perhaps a still greater share last year. No economy can sustain such a colossal rate of capital accumulation. At some point, China’s investment must run into rapidly diminishing returns.
On its face, that statement seems kind of silly. The most basic growth theory tells us that countries starting from a position of low capital and income should grow more rapidly than mature economies, and that investment will be higher than is sustainable in the long-run. While it may be true that "investment must run into... diminishing returns," I'm not sure what appeal to theory or empirical evidence would lead us to believe it should have happened in 2004.
But the real issue is this:
If investors were betting their own money, these redundant cement factories—not to mention steel mills, luxury flats and car plants—would probably never have been built. But China’s reckless investment owes a lot to the heedless lending of its banks. Chinese households still save about 45% of their income. They deposit about two-thirds of these savings in China’s four big state-owned banks, which lend about two-thirds of these deposits to state-run firms. The banks pay little attention to risk and do not expect much of a return: perhaps 40-50% of loans are non-performing. In fact, their lending is best seen as a form of state subsidy. If these subsidies were added to the government’s books, China’s budget deficit would balloon to 18% of GDP, reckons Diana Choyleva of Lombard Street Research, an economic consultancy.
Furthermore, there is suspicion that growth is currently being stimulated by the Chinese government's insistence on maintaining the yuan peg to the dollar, which has required an expansion of the domestic money supply. On this, the mixed signals in advance of next week's G-7 meeting just keep coming. From Forbes.com:
China's central bank denied Friday that Beijing plans to soon loosen the link between its currency and the U.S. dollar, though remarks by economists suggesting a change was imminent briefly shook financial markets.
A member of the monetary policy committee at the central bank, Yu Yongding, told journalists attending the World Economic Forum in Davos, Switzerland, that given the dollar's recent weakness, "now is the time to revalue ... We need more flexibility. That means revaluation."
However, an official in the People's Bank of China's information office said Friday that Yu was an academic adviser, not an official, and that his opinion did not reflect official policy.
"(Yu Yongding's) remarks are only his personal view, and the opinions of an academic. It does not represent the central bank's policy," an official in the central bank's information office said.
The noisy signals from the Chinese government notwithstanding , here's a prediction, from FXSTREET.com:
China will not undertake any sweeping revaluation of the yuan, but is likely to widen the trading band and gradually appreciate the unit over time to ensure an orderly transition to a more flexible currency regime, analysts said.
Maybe that prediction is not quite fearless, though.
Last year many market watchers wrote in their research reports and told the media that China, which has pegged the yuan at about 8.28 to the dollar since 1994, would revalue it upwards in 2004. But that did not happen. Now ahead of the meeting of finance chiefs of the Group of Seven nations on on February 4-5, analysts are more cautious, with the buzzwords being "possible", "mild" and "gradual".