Dragon Waketh, Elephant Sleepeth

Dragon goes offensive

China has unveiled one of the boldest moves by any country to tackle the fallout of the current financial crisis on its economy . Its 586 billion dollar stimulus will be spent in developing infrastructure (from NYTIMES)

At a time when major infrastructure projects are being put off around the world, China said it would spend an estimated $586 billion over the next two years — roughly 7 percent of its gross domestic product each year — to construct new railways, subways and airports and to rebuild communities devastated by an earthquake in the southwest in May.

There have been dire prognostications for china from a variety of sources following the current credit crisis including Roubini.

Note that China is an economy is structurally dependent on exports: net exports (or the trade balance surplus) are close to 12% of GDP (up from 2% earlier in the decade) and exports represent about 40% of GDP. Real investment in China is about 45% of GDP and, leaving aside the part of this investment that is housing and infrastructure spending, about half of this capex spending goes towards the production of new capital goods that produces more exportable goods. So, with the sum of exports and investment representing about 80% of GDP, most of Chinese aggregate demand depends on its ability to sustain an export based economic growth.

The trouble –however – is that the main outlet of Chinese exports – the U.S. consumer – is now collapsing for the first time in two decades. Chinese exports to the U.S. were growing at an annualized rate of over 20% a year ago; while the most recent bilateral trade data from the U.S. now show that this export growth has now fallen down to 0%. But the worst is still to come in the next few quarters: after an ok second quarter in the U.S. (boosted by the tax rebates) U.S. retailers hoped that the consumer downturn would be minor: they thus placed over the summer massive orders for Chinese (and other imported) goods for Q3 and Q4. But now the U.S. holiday season clearly looks like the worst that the U.S. will experience in decades and the result of it will be a huge overhang of unsold Chinese good. Thus, you can expect that orders of Chinese goods for Q1 of 2009 and the rest of 2009 will be sharply down dragging Chinese exports to the U.S. into sharply negative territory. And it is not just Chinese exports to the U.S.: until a few months ago the U.S. was starting to contract but the rest of the advanced economies (Europe, Canada, Japan and Australia/New Zealand) were growing at a sustained rate, thus boosting Chinese exports. But there is now strong evidence that a severe recession has now started in almost all of the advanced economies. You can thus expect that Chinese export growth to Europe, Canada, Japan, etc. will sharply decelerate in the next few quarters, thus adding to the fall in Chinese net exports.

Its interesting to see China to be so pro-active and push in so much money to stimulate its economy by investing in infrastructure which will only add to further gains when all this mess is sorted out. This is being done when China has already invested large sums in infrastructure for its SEZs and for Olympics.

Defensive Elephant


Closer home, though woefully inadequate in its infrastructure, India is still dragging its feet in coming up with a comprehensive infrastructure development proposal. Even if India spends one-tenth of the amount China is planning to spend to develop its roads, water supply, ports, railway and airports, it would go a long way in overcoming some of our shortcomings. At the sametime this would provide jobs to a lot of people outside of the IT industry. But what i would like to see is for Montek Singh, P Chidambaram and Manmohan Singh to use this opportunity to be even more aggressive.This way they won't be just stimulating our economy, they would be creating millions of non-IT jobs and lay down an environment where our manufacturing industry can thrive. But at this point, i am not holding my breath.