from Follow the Money

Good and bad news in the World Bank’s China Quarterly

February 12, 2008

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The good news in the latest World Bank China Quarterly.

One: The Economist can celebrate - for the first time in a long time, China’s growth really didn’t hinge on net exports in the fourth quarter (see Figure 2).

Even better, the World Bank believes that domestic demand growth picked up, so overall growth remained strong.  The World Bank’s calculations though assume "constant terms of trade"  -- which, as the Quarterly’s authors recognize in a footnote, understates the contribution of net exports to China’s growth in q4.  The rise in imports likely reflects an adverse terms of trade shock (economics speak for a @#$%! increase in the price of imported oil) as much as anything else. Still, World Bank is no doubt directionally right: net exports contributed far less to China’s growth in q4 than earlier this year - or in 2005 or 2006.

Two: The World Bank forecast that China’s current account surplus will stabilize in dollar terms in 2008 - rising by only $20b, from $360b to $380b. It is expected to fall from 11% of China’s GDP in 2007 to 9.3% of China’s GDP in 2008, roughly its 2006 level. I hope the Bank is right, thought, I would also expect China’s (nominal) import growth to slow as well if the global economy slows - whether from fewer imported components or weaker commodity prices.  Though right now there is little sign of moderation in commodity prices -- oil has remained over $90 and wheat is not cheap.   

Three: The Bank forecasts that China’s reserve growth will stabilize at around $460b a year. That is still an exceptionally large number, and by any reasonable standard, far too large an increase in reserves.  But the absence of any further increase in the pace of Chinese reserve growth would still be good news.  However, on this point, I am really not convinced -- not if the growth in the banks foreign asses and the CIC are factored in. The incentive to move money into China right now is too strong.

The bad news:

One: The World Bank does not expect the q4 surge in domestic demand to be sustained. The fall in the contribution of net exports to growth consequently implies less growth. For 2008, the World Bank forecasts that China will grow by about 9.5%.

Two: The gap between China’s exports and imports is big enough that a 20% y/y (nominal) increase in imports and 15% y/y (nominal) growth in exports only keeps the trade deficit constant in nominal terms.

Three: The Bank wasn’t able to find much evidence of a real rebalancing of China’s economy. Investment growth continues to outpace consumption growth. Industrial production continues to grow faster than services. So investment and industry are continuing to rise as a share of China’s GDP. The Bank -- stepping in for the IMF, which has yet to release its 2007 assessment of China’s economy, let alone look forward to 2008 -- notes:

" Investment growth in 2007 overall was only moderately lower than in 2006, and it continues to be higher than consumption growth, thus increasing its share of GDP. Similarly, industrial production decelerated, but it continues to grow faster than services, thus increasing its share of GDP. These developments suggest that measures taken so far to rebalance economic growth away from investment and industry to consumption and services have not yet had a noticeable impact. This is in large part because the fundamental drivers of investment in industry have not yet been much affected."

Pretty strong stuff. And accurate too, best I can tell.

The Bank also highlights another key point - for all the talk of the strong growth in Chinese consumption, consumption is still falling relative to GDP.

"During the last decade, consumption has grown more slowly than the overall economy, as the share of wage income and household income in the economy declined and household savings rate remained high."

Putting in place policies to reserve that slide should be a core policy goal.

The World Bank offers one additional bit of wisdom.

"Given the movements of the US dollar against other currencies, and the growing importance of countries other than the US as trading partners, it is increasingly necessary to look at and discuss China’s effective trade-weighted exchange rate, as opposed to the US dollar exchange rate."

Well said. Most of the real appreciation of the RMB in 2007 -- at yes, there was a real appreciation -- came from higher inflation, not exchange rate moves. The RMB was more or less flat against a dollar/ euro/ yen basket.

A final bit of good news: The World Bank’s web site indicates that Dr. Kuijs and Dr. Dollar will be answering questions about the Bank’s quarterly report on Tuesday February 19 at 9 am EST.  Submit your questions!

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