Dark clouds are looming over the global economy. The Euro zone may only manage a paltry 1.5 percent growth next year. Meanwhile in the United States, labor, residential and consumer markets have all experienced a decline in growth. With rising fuel prices, a growing debt burden and a negative savings rate, the United States also is poised for further decline in consumption.
And yet, the Chinese economy is bustling. In the last five years, China has maintained its annual GDP growth by around 10 percent, becoming the darling of the global economy. Foreign direct investment (FDI) and qualified foreign institutional investors (QFII) continue to pour into China.
But should the global economy go down the drain, what would happen to China? How long are the cords that bind the Chinese economy to the global economy? Would China experience a harsh fallout? How long would the impact be? With these questions, we went to Professor He Fan, Assistant Director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences.
How much is Chinese economy correlated to the global economy, and in particular, the U.S. economy?
The Chinese economy and the global economy are closely related. The integration of the Chinese economy within the global economy is most apparent in trade. With a heavy reliance on foreign trade, exports are increasingly important in driving the Chinese economy.
China's domestic demand and consumption have always been insufficient. Excluding the above two factors, exports remain the single greatest driver of the Chinese economy.
Still, the United States is in the center while China is on the periphery. It is the United States that drives trade. But the U.S. economy is in decline, which is reflected by reduced consumption and imports. As China's export of hi-tech products remains low, lower incomes in the United States will have a direct impact on China's exports.
The European Union and the United States are almost in the same position. If the European economy reduces imports, a chain effect will happen.
Currently, the Chinese economy is still in a very fragile state. If both domestic demand and exports are reduced, then the Chinese economy will experience reduced growth in 2007.
China is part of the newly burgeoning markets. When the United States and other key economies raise interest rates and reduce the money supply, the global flow of capital will be restricted and FDI to newly developing markets will suffer a rapid and severe decline. In 2005, FDI already showed signs of slowing (although it remains very high). In addition, a lot of foreign capital that flows into China is betting on the revaluation of renminbi, and they are not real investment. This hot money can flow out as easily as it comes in.
If the world's economy enters into a state of recession, how will this affect China?
First, China will experience delayed effects in its economy. Different policies will have different scopes and depths of influence. For instance, if the Federal Reserve raises interest rates or if the real estate market slides, there will be many small factors acting in the entire chain of events and it is very difficult to quantify the impact of each factor. Nevertheless, there will be an impact.
The delay will normally last for several months. There is a delay between the tightening of monetary policy and reduced investments. In trade, the impact will be delayed by roughly a quarter, taking into consideration contracts and future orders. Most supply contracts last for at least half a year and sellers typically make forecasts for future orders based on the state of the U.S. economy. This causes the delay.
What figures are there to tell us when the impact is being felt?
Investors should pay close attention to certain key figures that can identify when changes in the U.S. economy are being felt in China. A look must be taken at changes in incomes in the United States, because this will directly impact consumption by Americans. In addition, one must pay close attention to trading figures. By looking at these key figures, future trends may be indicated.
Renminbi is now appreciating and this may have an adverse impact on exports. Nevertheless, China's foreign exchange policy is inflexible and hence the impact may be of limited size.
Lastly, one needs to be able to tell which part of the cycle the global economy is in. The U.S. economy is in a state of adjustment. They currently have to solve their deficit problems and this will slow down economic growth for some time. The Japanese economy has been contracting since the late 1990s and has only recently made a comeback in the last two years. However, no one is sure how long this will last. The EU economy is now maintaining stability, with no major disappointments or surprises. After cruising for the last few years, the impacts of structural reforms are now being felt. The new member economies of the EU also will provide some stimuli.
Fundamentally, the sustained development of any economy will depend on structural adjustments. Once these are in place, China will be able to step up proactively.
DISCLAIMER: The information contained herein is based on sources we believe to be reliable, is provided for informational purposes only, and no representation is made that it is accurate or complete. This briefing should not be construed as legal, tax, investment, financial or other advice, and is not a recommendation, offer or solicitation to buy or sell any securities whatsoever.