Tuesday, November 11, 2008

China to the rescue?

China has unveiled the biggest economic stimulus package in history as Australia's Reserve Bank has  released the most gloomy set of local forecasts to date, predicting economic growth in this financial year of just 1.5% - the worst  in 17 years.

The 4 trillion yuan economic stimulus package is valued at 20% of China's GDP; almost 80% of Australia's. To be spent over two years, it is the biggest-ever injection injection of cash by a national government.

"This is an extraordinary package of significance not just to this economy but also to the economy across wider East Asia and the world," Prime Minister Kevin Rudd told Parliament. "It parallels what we saw from the Chinese government in response to the Asian economic crisis. It is very good news for this economy, very good news for the regional economy, and very good news for the global economy."

In a statement China's State Council said the money would be spent on 10 projects including “low-income housing, rural infrastructure, water, electricity, transportation, the environment, technological innovation and rebuilding from several disasters, most notably the May 12 earthquake.” China's official Zinhua newsagency reported that banks had also been directed to abolish credit ceilings and that taxes would be cut by "120 billion yuan".

"This shows that China is not taking the global slowdown lying down," said CommSec Australian equities economist Craig James...

"The US is fading in importance, taking its place is China, and economies such as Brazil, Russia and India more generally. The most significant developments over the next 5 to 10 years will be industrialisation in China and India, not the US-driven cyclical slowdown.

The Reserve Bank's Quarterly Statement, prepared ahead of China's announcement, said that Chinese export growth was slowing "significantly" and that Chinese industrial production had slowed to its slowest pace in 6 years - an 11% pace down from 18% a year ago.

The economies of Australia's major export customers would grow by just 1% during 2009 when weighted for the size of the economy at market exchange rates, "which would generally be considered a global recession," the Bank statement said.

The Bank's forecast for Australia is more gloomy than those of both the Treasury and the Reserve Bank, and would see the Australian economy crawling at its slowest pace since 1992.

The Reserve Bank is predicting economic growth of just 1.5% throughout the current financial year, and only 1% excluding the rural sector. The forecast released by the Treasurer Wayne Swan last Tuesday was for growth of 2.0%, and the IMF's forecast was for growth of 1.8%.

The Reserve Bank's forecast is not directly comparable with those of the Treasury and the IMF as it is on a "through the year" basis, describing growth through the financial year rather than the growth from one entire financial year to another, the method used by the Treasury.

But even accounting for that difference the Reserve Bank's forecast is still small. On a year-average basis it is predicting growth of around 1.6%, compared with the 2.0% predicted by the Treasury.

The Bank does not expect Australian growth to climb back to 3.0% until mid-2011. Inflation will not return to the top of the target zone until December 2010.

Finance Minister Lindsay Tanner told Parliament that another reason that the Treasury's and Reserve Bank's forecasts differed was that the Treasury had assumed further cuts in official interest rates, "whereas the Reserve Bank obviously cannot make any assumptions about future movements in interest rates, and out to June of 2011 it assumes that rates will remain where they currently are".

But the Bank's forecasts appear to be more gloomy than the Treasury's even accounting for the interest rate assumptions, and it is explicit in its report in saying that they are more pessimistic than the IMF's.

The Reserve believes that Australia's terms of trade are about to fall sharply, undoing the jump of 20% in the last year. it says the price of iron ore has dropped 60 per cent in 4 months, and that the spot price of thermal coal has slipped 25% beneath the contract price. Wheat prices and wool prices will also be weak.

Household spending will grow "only modestly" during this financial year, even with the government's $10.4 billion economic security package. It will pick up only "gradually" after that.

Housing finance figures released by the Bureau of Statistics Monday suggest that the Reserve Bank's first interest rate cut of 0.25 points in September had little effect. Loan approvals slid a further 2.7%.

John Garnaut reports from Beijing:

China's mammoth economic rescue package will focus overwhelmingly on construction, raising hopes China can help to stabilise global commodity markets and the regional economy like it did through the Asian Financial Crisis.

The Government's 4 trillion yuan package was short on details but well-connected economists say it will provide a huge boost to China's economy through to 2010.

"About 1.5 trillion of this spending is relatively new," said Huang Yiping, Citigroup's chief Asia economist.

"We're talking about adding 4 percentage points to GDP growth during the fourth quarter and 2 to 3 percentage points in 2009 and 2010."

Analysts expect the bulk of spending to go towards construction, although the State Council announcement also focused on equity, rural development, social services and the environment.

"Even with health and education the things they highlight is hardware, so there is going to be lots of construction going on," said Louis Kuijs, the World Bank's China economist in Beijing.

"Given that this came early, much earlier than people expected, it's a much welcome signal from Government that they are on the ball and they do want to keep things going," he said.

The Sunday night announcement caught economists and analysts by surprise. 

Many had been slashing China GDP growth forecasts after growth slipped to 9 per cent in the year to the September quarter and huge numbers of workers have since lost their jobs in the export and heavy industry sectors and construction.

Consumer and investor sentiment has recently plummeted.

But yesterday there were renewed signs of optimism.

"China will likely be an exception during the world recession, maintaining high growth, as it did after East Asian Financial crisis in 1997," said Zhang Yongsheng, a senior researcher at the State Council's Development Research Centre.

An official at the Bank of International Settlements told the Herald: "The impact is unquestionably positive for a number of the regional economies including Japan, Hong Kong and to some extent Australia. The question is the degree; it will take a few weeks to figure our the more important details."

The State Council announced a sharp policy U-turn away from fighting inflation towards supporting growth.

It said China would adopt "active" fiscal and "moderately active" monetary policies in order to achieve "steady and relatively fast" growth.

The first five of the Government's ten listed priorities will require major construction outlays:

- Public housing

- Rural infrastructure (water, irrigation, roads and power grid)

- Transport infrastructure (railways, highways, airports, and urban power grid)

- Health and education (local clinic service systems, renovating schools in inland provinces)

- Environmental development (urban water and sewage, water pollution, energy efficiency)

- Facilitate structural change and R&D (develop innovation and service sector)

- earthquake reconstruction

- Raise household income (increase grain procurement prices and subsidies)

- Value added tax reform, including 120 billion yuan in corporate tax cuts

- Increase bank lending to support growth, prioritising rural areas, small business, industry consolidation, technology and consumer loans.

The headline 4 trillion yuan price tag, which will be spread over two years, is equal to two-thirds of all central government spending in 2007 including social security and interest payments.

But economists warned it was premature for investors to get carried away.

"This 4 trillion number is quite a fictional number designed to inspire confidence," said Arthur Kroeber, principal of Dragonomics in Beijing.

"This is a signaling exercise to say we're not tightening anymore, we're letting things rip," he said.

Stephen Green, Standard & Charter's China economist, said: "Until we see the detail not only of how much extra money is being spent but where the money is coming form, as an economist you can't make any claim about the significance of this package."

Chinese text of the announcement.