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UPDATED: September 14, 2015 No. 38 SEPTEMBER 17, 2015
The ‘China Miracle’ Has Not Ended
Better fundamentals, more space for a pro-growth policy and favorable factors will keep the economy strong and competitive
By Mei Xinyu


While almost all the other emerging economies are experiencing massive turmoil, the Chinese economy is slowing down, with its GDP growth in the first two quarters of this year dropping to its lowest level since 1990. China's stock market plunge and a depreciation of the yuan caused by the country's foreign exchange reform also triggered turmoil in global markets in August. Some even claim that the yuan exchange rate will collapse, causing capital outflow to spiral out of control. Market fears about China's fall are more prominent than they have been in a decade.

However, if one looks at the economic fundamentals in China with an objective and dispassionate mind, it's apparent that they are still better than those of other major economies and emerging markets. The challenges the Chinese economy faces have been exaggerated. Chinese policymakers have more room to maintain economic growth than their foreign counterparts. In the mid-to-long term, China's business environment is much better than that of other major economies and emerging markets. Meanwhile, China has no impetus to trigger a "currency war" and is capable of ensuring the stability of the yuan's exchange rate.

Outshining rivals

It is undeniable that economic slowdown is occurring in China and will last for a certain period. This is natural after the world economy falls into low growth. Against the backdrop of a slowing world economy, it is unlikely for China to be the only economy that maintains high-speed growth.

However, compared with developed economies and other major emerging markets, China still has a higher growth rate.

China's foreign trade faces similar challenges. Its performance this year has been unsatisfying, and the 20-30 percent growth it exhibited in the first decade of the 21st century will no longer be seen. The decline is occurring not due to overarching internal factors but rather because the world economy has stepped into a long period of low-speed growth, and the hyper-globalization era, when global trade growth doubled economic growth, has ended.

The current decline of China's foreign trade is occurring against a backdrop of shrinking global trade. In the first quarter this year, China's exports dropped by 2.7 percent, while those of the United States and Japan dropped by 7.1 percent and 3.5 percent, respectively. Even India's exports slumped 20 percent, reaching its lowest level since the 2008 global financial crisis.

The global primary commodities market has slipped into a recession since 2012, which may continue 10-15 years. The U.S. Federal Reserve has changed its monetary policy, and almost all the major emerging markets have experienced economic turmoil in recent years. Some currencies have depreciated by more than 40 percent against the U.S. dollar within one year.

Such turmoil has inevitably affected China, and many market participants have changed their views on China's economic tendencies. However, as the world's largest manufacturer that has maintained a trade surplus, China is completely different from those exporters of primary commodities, which means that an economic collapse is much less likely to occur in China than in other emerging markets.

More room for policy

China's economic fundamentals are still sound, and the Chinese Government has more resources to ensure economic growth than many other countries. For instance, if China's central bank relaxes its monetary policy, it won't have to face the conflict of curbing inflation as other countries will.

Usually when a country's central bank intends to relax the monetary policy to stimulate the economy, the biggest challenge it will face is that relaxed monetary and fiscal policies will intensify the pressure of inflation. The strong fundamentals of the Chinese economy have created room for the central bank to relax the monetary policy because it doesn't need to worry about the backlash of soaring inflation.

How does such a judgment come about? China's inflation has remained low for a while, and its inflationary pressure has primarily resulted from imported inflation. The global primary commodities market has been in a deep recession, and the recession may continue for a long time. Therefore what China will face is not inflation but the pressure of deflation. Although prices of a few consumer products like pork have been rising quickly, such events are not enough to reverse China's deflation trend.

In emerging economies like Brazil, prices of primary commodities denominated in the local currency will still rise even if prices denominated in the U.S. dollar in the international market have declined, because the local currency in question is continuing to depreciate against the U.S. dollar. However, such events will not occur in China. A continual trade surplus has supported the yuan's exchange rate, so that its depreciation against the U.S. dollar won't be significant. Moreover, most of the capital China attracts has flowed to the real economy as direct investment, further stabilizing the yuan's exchange rate.

Favorable environment

In the mid-to-long term, China's overall economy, manufacturing and foreign trade will still have advantages that won't be affected by Western opinions or changed by some individual cases.

As China's national income has increased remarkably--and will continue to increase--the advantage of low labor costs has gone. This is an inevitable result of China's economic and social development, and the Chinese Government should not take the low income of laborers as a permanent advantage, because it must have its people share the benefits of development. However, when China loses the advantage of low labor costs, it must look elsewhere for a new competitive edge.

Along with the national income, its domestic market is also expanding at an unprecedented speed. To those investors mainly targeting the Chinese market, they are faced with unprecedented opportunities.

As its overall strength enhances, China is imposing a larger influence on international trade rules. China had to accept trade protectionism measures taken by other countries, but now, it is increasingly capable of persuading its trade partners to regard products made in China more fairly. Hence, those interesting in exporting manufacturers will face less trade protectionism.

Besides, certain advantages held by specific foreign countries are just temporary or will be offset by other factors. Take energy costs as an example. According to a report by the Boston Consulting Group, the manufacturing cost in the United States is 100 and that in China has risen to 96 due to the rise of energy prices. Chinese manufacturing companies that intend to invest in the United States will be attracted by cheap energy prices there.

The United States' energy price advantages have mainly come from the combination of the shale gas revolution and its control of oil and gas exports. However, since the international oil slump in June 2014, the overall primary commodities market has entered a recession that may continue for 10-15 years, which will therefore narrow the United States' advantage of low energy costs. The Clean Power Plan initiated by President Obama will raise the U.S. energy costs above even those in East Asia. Therefore it will be unrealistic to speculate that China's disadvantages will continue.

Considering China's advantages in infrastructure, industrial facilities, public services and human resources, as well as the determination of the Chinese Government and Chinese people in making consistent improvements, we can believe that China can remain competitive in its business environment, manufacturing and foreign trade.

A stable yuan

The depreciation of the yuan against the U.S. dollar and the stock market plunge in August have become an excuse for other countries to depreciate their currencies and for the slump of primary commodity prices. Some countries are criticizing China for launching a "currency war." Market expectations on further depreciation of the yuan are rising, while China's interest rate and required reserve rate cuts are considered by some market participants to be factors intensifying the yuan's depreciation.

However, the yuan has been appreciating against the U.S. dollar for 17 consecutive years since 1997. According to the National Bureau of Statistics, the yuan's exchange rate against the U.S. dollar had strengthened from 8.2898 in 1997 to 6.1428 in 2014. The recent depreciation of the yuan only represents part of the progress in market-oriented formation and two-way fluctuation of its exchange rate.

In sharp contrast, most currencies around the world have been depreciating significantly against the U.S. dollar within the past year. For instance, the euro and Japanese yen have both depreciated by 18 percent. In emerging markets, the Russian ruble and Brazilian real have depreciated by 40 percent and 34 percent, respectively. Compared with these currencies, the depreciation of the yuan is much milder. Therefore it is unreasonable to claim that China initiated a currency war.

China's economic fundamentals won't support the continual depreciation of the yuan: Its economic growth is still much higher than that of other countries; it still maintains a trade surplus and a high net inflow of foreign direct investment; and China's budget deficit and debt-to-GDP ratio are also comparatively low among major world economies.

Moreover, China's decision makers have no incentive to allow or even encourage the yuan's significant depreciation, let alone initiate competitive currency depreciation.

In the short term, a sharp depreciation of the yuan may cause deterioration in the balance sheets of Chinese companies holding debt denominated in U.S. dollars. Companies that can get low-interest dollar loans from the international market are powerful companies. Significant worsening of their balance sheets would certainly affect the stability of the national economy.

In the long term, if there is repeated turmoil in the financial market and significant depreciation of the yuan, it would mean the Chinese economy has entered a stage of stagnation after its economic takeoff. Such a condition is not attractive to China, which has been vigilant about avoiding this situation for many years.

The author is an op-ed contributor to Beijing Review and a researcher with the Chinese Academy of International Trade and Economic Cooperation

Copyedited by Kylee McIntyre

Comments to yushujun@bjreview.com

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