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Controllable contagion

7 February 2012 By Wei Gu

The International Monetary Fund misunderstands China. The latest China Economic Outlook estimates the effect of a severe euro zone crisis on the world’s second-largest economy – 2012 GDP growth would be 4 percentage points lower than the IMF’s base case of 8.2 percent. That’s not likely. And the fund’s analysis has other problems.

Maybe the IMF has been too distracted by its European responsibilities to notice that China is much less exposed to trade linkages than before the 2008 crisis. In 2011, net exports subtracted 0.5 percentage points from GDP growth, down significantly from a 2.5 percent contribution in 2007. Industrial sales for exports accounted for 12 percent of GDP in 2011, down from 17 percent in 2008. Domestic demand has picked up the slack. Consumption’s share of GDP rose above 50 percent in 2011.

Even if the global financial system turned out to be just as ill prepared for crisis as it was four years ago, China should be protected by its closed capital accounts. Foreign banks’ claims on Chinese banks are less than 1 percent of Chinese bank liabilities, while foreign assets, including sovereign debt, represent just 2 percent of Chinese banks’ total assets.

While exaggerating the risk from Europe, the IMF pays too little attention to the risks inside Middle Kingdom. There is the record $300 billion of local government debt, 4 percent of GDP, to be repaid in 2012. That will take a toll on local government finances, which are already struggling with lower revenues from land sales. Also, a property market slump will hurt investment, the biggest engine of China’s growth. Finally, inflation is still too high.

And if there were a slowdown, Beijing would not take the IMF’s advice for a fiscal package that equals 3 percent of GDP. Unlike the Europeans, the Chinese government would not be comfortable with a fiscal deficit of 5 percent of GDP, especially as central government debt, including contingent liabilities, already equals 80 percent of GDP, by the IMF’s own count.

The IMF is right to be cautious about the Chinese economy, but for the wrong reasons.


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