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Friday, June 20, 2003

China's Upward Growth Path

Morgan Stanley's China Team have revised their China GDP forecast upwards. I am happy about this for two reasons. Firstly because any good news on growth is always welcome, and secondly because when things looked pretty choppy a couple of months back and forecasts were being re-written downwards here, there, and everywhere, I managed to hang on in and stick by my pretty bullish outlook. It is beginning to look as if I may have been right.

We are raising our GDP growth rate forecast for China to 7.5% for 2003 from 6.5% because of stronger-than-expected exports and the improving US outlook. We are increasing our growth rate forecast for exports to 21% for 2003 from 12%. On April 2, we reduced GDP growth rate forecast to 6.5% from 7% because of SARS-related weakness in domestic demand. We have not changed our view on the impact of SARS. The current upgrade is entirely due to more favorable global economic environment.

China’s exports are surging beyond our expectation. We originally believed that China’s exports grew a rate of 22% last year because of the low base the previous year and that the rate would normalize in 2003 to 12%. Instead, growth for exports has accelerated this year to 34.3% for the first five months of the year. It appears that China is entering another export boom for two reasons:

European companies look to be shifting their production to China through either shifting to an OEM model or relocating their factories. For example, a number of soft goods vendors have been following their US counterparts in shifting to an OEM model. A strong euro has also helped. It appears that Europe explains half of the upside surprise in China’s exports this year. China’s export base is broadening in terms of product range and producers. Private companies, for example, raised their exports 163% in the first four months of 2003, increasing their share of total exports to 8.4% from 6.6% last year. China’s private sector has finally learned how to produce products that western consumers want to buy. This new force should drive China’s exports for many years to come. The range of export products has widened dramatically. Because China has hundreds of millions of surplus workers, it can virtually create economies of scale in every product that exists in the world. This represents a weapon against protectionism. Even though EU imposes quotas on about 3000 Chinese products, China’s exports to Europe rose 45% in the first five months.

However, China’s imports are surging even faster that exports because of rising commodity prices and the takeoff in car sales. The Commodity Research Bureau’s index has averaged 239 so far this year compared with 211 last year. It is likely to average about 240 for the year as a whole. China depends on imports for raw materials. The rise in the CRB index represents deterioration in China’s terms-of-trade. This factor alone contributes about 4 percentage points to China’s import growth rate beyond what we expected at the beginning of the year. Motor vehicle imports rose 123% in the first four months of this year, twice as strong as we had expected. China’s auto sales are up by about 60% so far this year. As China cuts import tariffs because of its obligations after joining the World Trade Organization, auto imports are surging. This factor contributes about 2 percentage points to the increase in our import growth rate forecast. Half of our import upgrade is embedded in our export upgrade. China’s incremental exports are highly dependent on imported components. Domestic value added is about half. Localization does happen over time. The value added component of China’s exports is less volatile than total export revenue.

Strong export growth does not mean that China’s currency should appreciate, in our view. The army of surplus workers is so massive that wages in the export sector are not inflating at all. Until China runs out of its surplus labor, there isn’t a good case for its currency to appreciate. Some argue that China could face protectionism if it doesn’t revalue its currency. This is essentially telling poor people not to work too hard because it produces pressure on rich people. Let protectionism come, I say. It still won’t stop China. Other countries will always be there to buy things at cheaper prices if they don’t produce such products themselves. This angle alone should allow China’s exports to grow steadily.
Source: Morgan Stanley Global Economic Forum

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