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Monthly Economic Indicators

Special Topic: The rise of China and its importance for New Zealand

The Chinese economy has undergone a period of rapid expansion in recent times, with real GDP growing close to 10% per annum, on average, over the last decade, peaking at 14% in 2007.

Over this period China’s integration with the rest of the world developed, including establishing significant ties with New Zealand and our main trading partner Australia.  While this growing exposure has provided significant benefits, it comes with risks if their economy were to slow.

China grew rapidly and became internationally integrated at the start of the decade...

In the early and mid-2000s China’s trade with the rest of the world increased significantly, with merchandise exports averaging a 22% rise per annum between 2000 and 2008.  The integration was helped by China joining the World Trade Organisation in 2001.  Soaring exports resulted in large current account surpluses, peaking at 11.0% of GDP in 2007, and the build-up of the world’s largest foreign exchange reserves.

At the same time, China has undergone a period of industrialisation, resulting in significant investment, especially in infrastructure, with investment rising from 34% of GDP in 2000 to 41% in 2008 (Figure 7).  Surging exports and investment caused China to average 10% growth between 2000 and 2010 (Figure 7), resulting in real GDP being 140% larger than it was in 2000.

Figure 7 – China real GDP growth, and exports & investment share of GDP
Figure 7 - China real GDP growth, and  exports & investment share of GDP.
Source: National Bureau of Statistics of China)

… before being hit by the global financial crisis...

China’s growth peaked at an annual rate of 14.0% in the first half of 2007, before slowing to 6.2% in Q1 2009.  The slowdown was the result of a collapse in external demand due to the global financial crisis (GFC).  The GFC resulted in recessions in most developed countries which import a large portion of Chinese manufactured products.  At the same time as exports fell, the People’s Bank of China (PBOC) raised interest rates and took measures to reduce credit growth.

...then recovering with the help of stimulus

With external demand falling, the driving force of the economy switched to domestic spending, helped by the Chinese authorities providing substantial stimulus.  The government undertook large amounts of infrastructure spending, which provided a boost to investment.  Tax cuts and consumption subsidies resulted in growing private consumption.  However, most of the rebound came through investment, with limited rebalancing towards private consumption.  A later rebound in exports from the global recovery, along with the domestic pick-up, meant growth reached an annual rate of 11.9% in Q1 2010.

New Zealand has benefited significantly

China’s growth and international integration have made the country increasingly important to the New Zealand economy, recently becoming our second largest trading partner.  New Zealand exports to China were 4.6 times larger in 2009 than they were in 1999, increasing their share of total exports from 2.9% to 8.4% (Figure 8). Most of the export growth came from dairy products, as Chinese incomes rose, fuelling protein demand, and from logs, used as inputs into their investment spending.  The export surge has been most pronounced since 2007, assisted by New Zealand becoming the first OECD country to sign a free-trade agreement with China in April 2008.  China has also become an increasingly important market for our service exports, mainly tourism and education.

Figure 8 – Share of exports and NZ terms of trade
Figure 8 - Share of exports and NZ terms  of trade.
Source: Statistics New Zealand

The massive recent demand for New Zealand exports from China helped New Zealand weather the GFC better than most OECD economies and has helped result in record levels for our commodity prices in 2010.  Elevated commodity prices have lifted the terms of trade to historical highs and boosted domestic incomes (Figure 8).  China’s growth was also positive for some of our major trading partners which export commodities and manufacturing inputs to China - mainly Australia and emerging Asia - providing indirect benefits to New Zealand.

There are signs of a slowdown...

China’s annual growth in the June quarter of 2010 slowed to 10.3%, from its recent high of 11.9% in the first quarter.  The drivers of the slowdown were moderating investment and industrial production; as stimulus measures began to fade, the housing market is cooling and government infrastructure spending is slowing.  Indicators point to easing growth in the second half of 2010.  Both service and manufacturing PMIs have been falling in recent months, but remain expansionary, suggesting that growth in economic activity will moderate later in the year (Figure 9). In addition, lower consumer and house price inflation suggest the economy is slowing.

Figure 9 – Industrial production and PMI
Figure 9 - Industrial production and PMI.
Source: National Bureau of Statistics of China

The latest Chinese trade data show that import growth is beginning to fall, led by commodity imports.  This provides a risk for future exports from New Zealand and Australia to China.  Also, the latest Fonterra auction and CBA Commodity Price Index suggest that New Zealand export prices may be easing, although still at high levels.

...and risks are present...

Some commentators are concerned about the development of asset price bubbles in the housing and equity markets as a result of the recent credit boom.  House price growth peaked at an annual rate of 12.8% in April, but has since eased to 11.4% in June.  While the Shanghai Composite share index had increased almost 100% between 2000 and the beginning of 2010, it has since fallen led by a 23% drop in the second quarter.  The drop-back in asset prices has been partly the result of tighter monetary conditions, achieved through quantitative controls.

China’s rapid recent growth was based on booming credit and significant investment spending.  There are questions of the extent of

bad debts arising from over-extension of credit and whether the investment growth can be maintained.  Also, the expanding economy has put pressure on consumer prices and wages, which may pose a risk to future growth if drastic monetary tightening is required to ease inflationary pressures.  Tightening has already seen the government limit lending growth in order to stop the economy from overheating.

On 19 June 2010 the PBOC announced the end of a two-year peg of the exchange rate to the US dollar (USD). The announcement allows for a slow rise against the USD over time, potentially helping global rebalancing, in the form of the Chinese economy shifting towards consumption and heavily-indebted countries (for example the US) away from consumption.  However, the Yuan has only appreciated about 0.8% in the subsequent month, and forward contracts predict it will only rise less than two percent over the next year.

...but China will continue to lead the global recovery

Although growth is likely to slow further in the second half of 2010, it is likely to remain strong, with July Consensus forecasts predicting calendar year growth will be around 10% in 2010 and 9% in 2011.  We will be doing further work on the sustainability of Chinese growth and its effect on Australia and New Zealand.  However, at this stage, while there are risks surrounding the expansion of China, we do not expect any of them on their own to derail the economy in the near term, although there will be variability in the growth rate.  Long term, the most likely scenario is strong growth, although at a lower rate than seen in the previous decade.  This will provide ongoing benefits for New Zealand, as China continues to grow as a trading partner and its demand for our commodities and services remains strong.

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