Adviser > News > November 2008 > Economic Matters
Economic Matters
RLAM's Economist, Ian Kernohan, explores the impact of a slowing global economy on Chinese growth and looks at the efficacy of likely interest rate cuts in the UK.
Chinese growth set to slow
For the past ten years and certainly since WTO accession in 2001, China's growth has been driven by exports to the rest of the world and stellar growth in Fixed Asset Investment (FAI), with a large chunk of the latter driven by exporting industries and a booming property market. The global economy is now slowing fast and the boost from trade is fading rapidly. In turn this will have a knock on effect in FAI, which is already suffering from a turndown in property prices. The government and consumer sectors are as yet too small to offset the backwash from global recession on exports and investment, so overall economic growth will slow next year to 8% and possibly lower.
Low debt and policy reforms will help long term outlook
This slowdown is however a blessing in disguise and while the outlook is for slower growth over the next 12 months, 7 - 8% GDP growth is hardly a disaster and the economy possesses a number of key supports. First, unlike the situation in many developed economies, neither the household or government sector are particularly indebted and while it will take some time to reduce the household savings rate, the government can act more quickly to give the economy a substantial fiscal boost. The prospect of a major global slowdown has highlighted the need to alter the growth model away from trade and trade related investment towards more balanced domestic demand led expansion. This will provoke reforms which should have happened some time ago and will put China on a better economic footing in the long term. Key reforms are in rural property rights and the creation of a welfare net to protect people in the event of unemployment and sickness. It is encouraging that the authorities appear keen to make these changes, with recent falls in headline inflation providing another window of opportunity to ease policy.
In summary, western commentators have been too complacent about the effect of the global slowdown on China's short term economic prospects - consensus numbers still have to come down for 2009. A change in the mix of growth away from export and property related FAI towards domestic consumption will have implications for commodity demand, although given the recent falls in commodity and commodity related share prices, much of this may already be in the price. Looking beyond the near term into 2010, China still possess key ingredients for a sustained economic expansion, at least until 2015 when the effect of an ageing population will begin to be felt. The Government will now bear a larger share of the economic burden, both through the creation of better welfare provision and other large infrastructure projects.
Fiscal boost in the UK
The Bank of England will continue to reduce interest rates, yet there must be some doubt about how effective these will be in boosting economic prospects, given a situation of falling collateral values (aka house prices) and a very low savings ratio. Lower sterling is the other main transmission mechanism of lower interest rates, however at least in the near term, the effect of devaluation is blunted thanks to the global nature of the current slowdown. So it is right that fiscal policy share at least some of the burden of economic support and this means a boost to government spending, rather than tax cuts, which may be saved rather than spent.
To turn Ronald Reagan's famous remark about governments being part of the problem rather than the solution on its head, in the current situation, government is the only reliable actor in the economy: we're not sure how firms and households will respond to lower interest rates, but we can have greater confidence that when the government says it will spend money, it is likely to do so.
Of course, there will be some complaints about the hit to the public finances, but paradoxically, without the fiscal boost to growth the public finances would be in an even worse state, thanks to an even deeper recession.
Now that the UK recession call is pretty much universal, the debate has centred on the likely length and depth of the downturn. The absence of an ERM straight jacket and the relatively low starting point for inflation argue for a relatively short-lived and shallow downturn. However a lot depends on how quickly the savings ratio rises from its historic low. Moreover, since we have just witnessed the greatest global banking crisis since the 1930s, it is too soon to rule out a much deeper recession, at least as bad as that of 1991/92.
Asset allocation of the Scottish Life Managed Funds as at 31 October 2008.
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This article represent the views and opinion of Royal London Asset Management.
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