– Wei Gu is a Reuters columnist. The opinions expressed are her own –

As the financial crisis forces American consumers to curb their shopping binges, the world starts to realize that China’s high savings level has some upsides, marking Chinese consumption as the most resilient in the world.

Beijing has to, however, be careful in how far it goes to encourage domestic spending to help the economy ride the global downturn. Credit-driven booms and consequent busts from the United States to South Korea are pointers to the need for caution.

About 75 percent of Chinese consumers plan to maintain or increase spending in the next 12 months, while almost 60 percent in the United States and the European Union expect to reduce spending, a recent Boston Consulting Group survey found.

Although economists have been saying China needs to reduce its savings rate to rebalance the economy, its high savings rate has turned out to be an asset rather than a liability for itself and the world during the economic downturn.

Chinese consumers are more insulated from the economic turmoil because they are less leveraged. Only 12 percent of Chinese said they are financially insecure, while more than a third of U.S. and EU respondents felt they were in financial trouble, according to the BCG survey.

Contrary to the common belief that the Chinese all behave like Grandet — the miser in Balzac’s novel Eugenie Grandet — the Chinese have been quite willing to spend in recent years. Retail sales growth has outperformed GDP growth for five straight years.

The reason that Chinese still save nearly half their income is because consumption growth cannot keep up with the speed of wealth creation.

During exceptionally high economic growth, much of the increased income will be saved. Spending behavior does not change overnight.

When a Chinese peasant wins the lottery, instead of buying a yacht or a Jaguar, he is more likely to put most of the money in the bank.

Nevertheless, Chinese consumption will catch up as its citizens get more accustomed to a richer lifestyle. But the process will take at least two decades for structural changes like urbanization and demographics to run their course rather than the two years going by some shopping incentives introduced recently by Beijing.

CONSUMER ENGINE

It is hard to imagine that China’s consumption contribution to GDP was even higher than the ratio in America nearly three decades ago, but people lived miserably then. In 1981, when China just started to open itself up to foreign trade, consumption accounted for a whopping 93.4 percent of GDP.

Saving was a luxury at that time because most families struggled to make ends meet. Families grabbed whatever consumer goods they could find because of shortages in almost everything from eggs to fabrics.

The West has for years clamoured for more domestic spending on the Chinese side, but they have to be careful in what they wish for. If the Chinese become big spenders overnight, who is going to finance U.S. consumers?

Also, imagine the pollution when the car penetration level in China reaches that of America, which means the number of cars in what is already the world’s largest market would run into several hundreds of million.

Before China establishes a social safety net for its citizens, it is irresponsible to ask them to squander their nest eggs away on bags and cars.

The South Korean credit card bubble has shown that a credit-driven boom, if not controlled, could end in tears.

To promote private consumption after the technology bubble burst, Seoul cajoled people to use credit cards by offering them tax deductions and even a shot at a lottery.

Korea’s consumption soared as a result, but quickly slumped after credit card default rates surged as people started to spend beyond their means.

Beijing has been flooding the market with cheap credit and throwing around all sorts of incentives, such as tax rebates, subsidies and shopping coupons to encourage domestic spending to boost economic growth.

The strategy may have succeeded in boosting short-term spending, but China should not overdo the incentives in order to avoid Korea’s pitfalls.

Persuading Chinese consumers to spend a lot more when wealth creation slows is both impossible and potentially risky.

Instead, officials should ensure they put the extra savings to better use to reduce global imbalances. Chinese surplus savings end up as investments in U.S. Treasuries, which effectively financed U.S. consumers and homeowners in their economic bubble inducing binges.

China should redirect surplus savings to other developing countries and emerging markets, those with abundant resources and low labor costs, but in need of capital.

These economies, from South America to Africa, are the future growth engines of the global economy. By doing so, China will help reduce the global imbalance rather than worsen the problem.

– At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund –
(Editing by Mathew Veedon)

– Wei Gu is a Reuters columnist. The opinions expressed are her own –

China investors should care about three major numbers this year: 8 percent economic growth, its 4 trillion yuan ($586 billion) stimulus package, and the 10 industries revitalization plan.

The first is the government’s economic growth target and the second is a spending plan to shield the economy from the global financial crisis.

A lot has been said about the first two numbers, but not enough about the third. Indeed, there are at least three misunderstandings about the latter.

First, perhaps misled by the word “revitalization,” many people talk about the plan as if it is another set of recovery measures to boost investment demand. On the contrary, it mostly contains policy measures aimed at reducing supply.

Thus, there is little reason for investors to be disappointed if their favorite sectors, such as property, are not included.

The 10 industries consist nine sub-sectors of manufacturing and one service sector related to that, logistics, which have all been hit hard by the collapse of overseas demand.

The plan is designed to buy time by achieving an orderly reduction in these industries’ capacity, rather than a reduction that could become disorderly if left to market forces, says Qing Wang, Morgan Stanley’s China economist.

But will that work? That leads to the second myth.

The revitalization plan is mostly about state-owned companies buying other state firms and many in China believe that if the government has a wish, it has a way.

But that is not always the case. Companies and local governments try their best to avoid arranged marriages. History has shown that such deals can take as long as a decade to complete.

In the current economic environment, designated acquirers won’t be interested in taking on more workers and equipment and local governments hate to lose tax revenue from factories on their turf.

Even if the government can drive consolidation, they cannot successfully compel integration, thus little synergy can be extracted out of those deals.

Investors should also bear in mind that Beijing’s top priority is to protect jobs. Any company with plans of cutting more than 20 jobs needs to brief local authorities one month in advance. So far, state-owned companies have largely refrained from staff reduction.

But if Beijing does not allow layoffs and closures, then it will be impossible to reduce capacity even after arranged mergers.

So, don’t expect restructuring plans to lead to much capacity reduction, even though it is desperately needed.

A point in question is China’s steel industry. Now the world’s largest steel maker, China last year produced 660 million tonnes of crude steel, 100 million more than demand.

The government has said it will strive to eliminate just 25 million tonnes of obsolete steel production capacities by 2011, only a quarter of the current extra capacity.

The third myth is that all industries are treated equally. The reality is that policies for those 10 industries differ widely.

The priority for the electronics industry is “rural demand,” for textiles “upgrade and move up the value chain,” for nonferrous “contraction,” and for equipment “strengthening and innovation.”

For steel, the focus is consolidation, as demand is not likely to come back soon.

“The best time for steel is over frankly,” said Larry Wan, a fund manager at KBC Goldstate Fund management in Shanghai.

“The government is motivated to cut capacity, but it will face strong resistance from below.”

Beijing also wants the auto industry to consolidate. It specifically said that it wants the top 14 auto makers to be reduced to 10, but has not set a target for capacity reduction. Instead, it is planning for capacity to grow 10 percent annually in the next three years.

The policy for autos is more about stimulating demand. Measures include reducing the sales on smaller cars, providing subsidies to encourage rural residents to replace old vehicles, and making more financing available for consumers.

It might be tempting for investors to dismiss Beijing’s interventionist approach. But they should still study the plan.

The government has never before come up with such a sweeping package that includes detailed long-term goals for so many key industries. It could serve as a curtain raiser of future industrial policies.

“The plans have made it clear where the government support lies,” said Yang Chengzhang, chief economist at Shenyin Wanguo Securities. “Every company needs to position itself according to the plan to get maximum room for its development.”

– At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund –

– Wei Gu is a Reuters columnist. The opinions expressed are her own. –

Beijing may criticize American consumers for spending money they do not have, but the truth is Chinese leaders do the same, they just make sure it doesn’t end up on their account.

In its $585 billion economic stimulus package, the central government is contributing just a quarter of the funds needed, leaving the rest of the tab to banks, local governments and the private sector.

By comparison, the U.S. Treasury is expected to fund all of America’s $787 billion economic recovery plan by incurring more debt through the issuance of Treasury bills.

But just like in the West, there’s no such thing as a free lunch.

The Chinese central government might have successfully transferred most of the risks and financing costs to banks and local governments from its own balance sheet, but if bad debt piles up the chickens will still come home to roost in Beijing.

China and the United States leverage themselves in different ways. America uses government credit to raise money directly from the market. China uses quasi-government financing, so that the real costs of the plan — though indirectly ultimately a cost to Beijing — are impossible for investors to gauge.

Beijing will have no trouble finding local governments and banks eager to help finance the stimulus plan for two reasons: it’s in their political interest to please the central authority, and with liquidity abundant, they are eager to lend and projects in the stimulus plan at least have government backing.
Indeed, a record for new yuan lending in January shows banks have already responded to Beijing’s call to support stimulus efforts. But there is a serious downside to the Chinese model.

“The main problem with relying on banks rather than incurring a larger explicit budget deficit is one of transparency,” said Tao Wang, head of China economic research at UBS. “Relying on bank financing makes it less transparent how much spending takes place in relation to various stimulus projects.”

China’s budget deficit is expected to swell only modestly due to spending associated with its economic recovery plan, to 3 percent from 0.6 percent last year. In contrast, the U.S. federal deficit will shoot up to 12.3 percent this year from 3.2 percent.

WHY IS BEIJING SO KEEN?

Many economists say they do not understand why Beijing is so keen to keep the financing off its books. The state’s balance sheet is probably the strongest in the world and they have no qualms about using state power to drive economic growth.

Some Chinese economists think the government is trying to avoid the scrutiny of the National People’s Congress. But the NPC has traditionally behaved as a rubber stamp parliament and there is little reason to believe that would change now.

Hongbin Qu, HSBC’s China economist, reckons that it just comes down to the Chinese way of doing things. He cited the way Beijing handled the costs of last year’s Sichuan earthquake as an example — the central government called upon 21 richer provinces to each partner with a heavily hit county to take responsibility for the rebuilding efforts.

“The Chinese government is used to buying a meal and getting someone else to pay,” Qu said. “The central government really should dole out more money because public service is its responsibility.”

Beijing has used smoke and mirrors to maximize government spending in the past. The previous administration issued government debt of $746 billion to fund almost $3 trillion worth of projects to pull China out of the Asian financial crisis — again ultimately spending four times what it put in.

Beijing has asked banks to issue low-interest “policy loans” of more than 10 years to local government entities for stimulus-related infrastructure projects. With very little down payment for the loan required, the banks have no buffer built in for potential downsides. Moreover, investors will not know how much those potentially problematic loans are, as it will just be part of the overall bank lending.

If this approach is pursued heavily, it could eventually put at risk banks’ balance sheets, their reputations and investor confidence. But again, because the projects are ultimately backed by the central government, the banks are only too happy to lend.

Also worth watching will be debt issued by local government investment vehicles. Local governments are not only expected to contribute to the 4 trillion yuan stimulus package, they have also pledged 18 trillion yuan to supplement the national plan.

But local governments don’t have the money and are not legally allowed to run deficits or borrow. They get around this restriction by setting up vehicles that package their debt like company debt, which is expected to flood the market this year.

Many of these vehicles generate little profit on the operating level and the debt is guaranteed by equally weak companies, but they still get triple A ratings because of the implicit guarantee by the government.

“On the surface the government has little financial burden but the reality is it just put risks at another place,” said Vincent Chan, head of China research at Credit Suisse.

– At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund. –

– Wei Gu is a Reuters columnist. The opinions expressed are her own –

Abundant liquidity, government support and a strong yuan fueled Chinese companies’ overseas buying spree.

But since they went out at the peak of the market and did not have a clear strategy for acquisitions, it should come as no surprise that most of those deals have turned sour. Once bitten, twice shy.

Crisis-ridden companies around the world are hoping that cash-rich Chinese buyers will come to their rescue, but the Chinese are not eager after getting their fingers burnt.

Chinese regulators are now giving more scrutiny to foreign deals, forcing interested buyers to lay out the most pessimistic scenario when seeking their approval.

Bankers said Beijing is skeptical about buying everything except resources, which is seen as important to China’s strategic interest and involves few integration challenges.

BUYING THE BRAND

Chinese manufacturers thought they had found a winning strategy by making goods cheaply in China and slapping a prestigious Western brand on it.

But the strategy hit a wall as companies such as TCL struggled for years to turn around businesses it bought in North America and Europe.

Lenovo’s purchase of IBM’s PC unit was widely lauded as a rare success until it announced a broad restructuring and profit shortfall earlier this month.

The acquired unit has a high exposure to large enterprises in developed markets, a segment that was hit hardest by the economic downturn, said Xin Zhao, an analyst at Cazenove.

“Before China caught the globalization wave our teachers in the West ran into problems,” said Yang Mianmian, president of China’s electronic appliance giant Haier, which last year spurned an offer to buy GE’s electronics unit.

“The financial crisis has changed our thinking and now we are looking more at rural demand.”

One of the potential pitfalls has been overpaying. Chinese buyers lack experience in valuation methodology and are at risk of paying too much. Moreover, they often do not have a strong understanding of the target experience, and tend to underestimate culture differences and powerful unions.

Some deals have not only incurred hefty losses but turned into a public relations nightmare as the crisis bites harder.

Take the example of Ssangyong Motor Co, South Korea’s No. 5 automaker, which filed for bankruptcy on Jan. 9 after getting hit by the global slump in car sales.

Analysts reckon SAIC Motor Corp, which owns 51 percent of Ssangyong, would be prepared to let the sport utility vehicle maker fail.

Some South Korean media have accused SAIC of all along planning to strip Ssangyong’s technology and dump it afterwards.

“Chinese companies have now realized there are many pitfalls on the road abroad and are learning from their experience,” said David Yu, partner at Llinks Law Offices, who advised SAIC on the deal.

FINANCIALLY SOUND

Chinese companies are financially sound — three state-owned banks trail only Warren Buffett’s Berkshire Hathaway on the global cash-rich groups list. But they’d better not try to bottom fish now.
The temptations are great — many Western brands long seen as out of Beijing’s reach are now fighting for Chinese attention.

Ford, for example, is looking for buyers to take up Volvo and a bank representing it has pitched it to at least three Chinese automakers.

“Chinese automakers need to be extremely cautious about those seemingly once-in-100-years opportunities to avoid failures which will not be recovered in many decades,” said Yankun Hou, an analyst with Nomura Securities.

To avoid more big losses, Chinese companies should cut their teeth on smaller deals in growing industries and markets, mindful that acquiring technology is much easier to manage than buying brands because it doesn’t involve taking over the whole operation.

“It is not clear that all the bad news is yet out, so assessing a target bank’s exposure is still challenging for any investor,” said Holger Michaelis, a partner with The Boston Consulting Group in Beijing.

“The timing however appears good for screening potential targets, but with a focus on smaller deals in less risky segments, like wealth management and asset management.”

– At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund –

– Wei Gu is a Reuters columnist. The opinions expressed are her own –

China is pulling all the stops to keep the economy growing by at least 8 percent, a pace considered necessary to absorb millions of migrant workers and graduates that hit the job market every year.

Ironically, with all its attention focused on the vigorous “defense of the eight”, Beijing risks losing sight of its ultimate goal — creating enough jobs to preserve social peace — and may end up engineering a jobless recovery.

Not only the rate of growth is important, but also its sources. Expansion led by capital-intensive industries will not be as effective in creating jobs as one driven by more labor-intensive sectors.

Statistics of the past three decades show that with the focus on investment, rise of heavy industries and China’s wish to move up the value chain, more and more economic growth has been needed to create the same number of jobs.

The latest efforts to shield the world’s fourth largest economy from the global financial crisis, including a nearly $600 billion stimulus, also focus on capital-heavy infrastructure projects.

“If your concern is jobs then targeting growth is not the best approach because the link between growth and jobs is not fixed, and different sources of growth have widely different impact on employment,” says Bill Bikales, a senior economist for the United Nations Development Program.

“It is unusual that China starts with a growth target,” He added. “(U.S. President-elect Barack) Obama has spoken several times about how many jobs he wants to create but he does not say how much growth he wants to produce.”

To boost employment and maintain social stability, Beijing should put more emphasis on labor-intensive sectors and move away from capital-intensive heavy industries that have been favored in recent years, several economists say.

Traditionally, China’s development policies have favored capital-intensive industries, such as auto, steel, machinery that are seen as key to modernization and sustained economic growth.

NEGLECTED LIGHT INDUSTRIES

In recent years the authorities have tried to move away from low value-added light industries, even though they have played a big part in the boom of the past three decades and have a potential to create more jobs, especially for unskilled workers.

China reckons it needs to add about 9 million jobs every year — about 3 percent of its urban workforce — for the 8.4 million some villagers moving to the cities every year. However, since early 1990s it has met the goal only when growth exceeded 10 percent. And over the years the link between growth and jobs has weakened.

In the 1980s, each 1 percent increase in gross domestic product led to a 0.3 percent rise in employment. This has dropped to a mere 0.1 percent jobs gain in the following decades, leaving the authorities undoubtedly frustrated that the country’s stellar growth performance has had such a modest impact on jobs.

The stimulus package and other measures aimed to help leading industries may help Beijing hit its growth targets, but may again disappoint leaders on the jobs front.

“Investing in capital-intensive sectors can stimulate growth in the short-term but has limited impact on employment,” said Yang Du, chief of division of labor at the Chinese Academy of Social Science, a top government think tank. “This might lead to a jobless recovery.”

Urban registered jobless rate stood at 4.0 percent at the end of September, which does not count migrant workers. The real unemployment is closer to 9.4 percent, reckons the Chinese Academy of Social Science. The World Bank estimated in its December report that right now, China needed to grow 9.5 percent to keep unemployment steady.

Premier Wen Jiabao has urged state-owned companies to “do everything possible” to refrain from job cuts. He said the auto industry’s current difficulties concern him the most because the industry has a long supply chain.

But as China’s companies are increasingly privatized and more profit-minded, ordering them to refrain from laying off people is unlikely to prove very effective.

The premier is probably betting on a wrong horse with his focus on the carmakers, not only because cars are being sold less briskly but also because growth in such capital-intensive industries is not effective in absorbing migrant labor, a group that the financial storm hit hardest.

Most of China’s migrant workers are employed by small private exporters. Large investment concentrated in a few industrial sectors could make urban-rural income disparity and overall inequality even worse.

World Bank economists Jianwu He and Louis Kuijs suggest China should shift its focus to the services sector from industry, and recommend Beijing to let consumption, instead of investment and exports, to play a bigger role in the economy.

The authors acknowledge, however, that changes cannot be made overnight. Otherwise growth will collapse and employment conditions will still suffer.

“Reducing the importance of investment needs to be a gradual process and needs to go hand in hand with higher efficiency, more reallocation of labor out of agriculture, better allocation of capital, and a redirection of factors and resources towards sectors that require less capital,” they wrote in a report.

– At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund.–

– Wei Gu is a Reuters columnist. The opinions expressed are her own. –

Beijing risks inflicting even more damage to the world economy by reflexively slowing market reforms in response to the financial crisis. But China’s leaders should quicken, not slow, the pace of reform to help it ride through the storm.

This December marks the 30th anniversary of China’s decision to embrace market liberalization but with growth becoming the No.1 concern in China, reforms have taken a back seat.

To stimulate the economy, Beijing has resorted to non-market measures that have worked in the past, such as building big infrastructure projects to boost public spending.

Further, the yuan’s recent slide has prompted some market-watchers to speculate that policymakers are deliberately encouraging the depreciation of the currency to support exports.

But those policies will not pull China out of this turmoil. The multiplier effect of government infrastructure investment is much weaker than during the Asian financial crisis because China’s roads and bridges are much improved. And with demand slumping almost everywhere abroad, a small yuan devaluation will not save exports, especially when the currencies of other Asian nations are seeing much bigger falls.

China has to switch from its export-oriented growth model to a new one driven by domestic demand.

To that end, Beijing should introduce further reforms, such as improvements to the social security net, reforms on healthcare, education, land tenure and taxation systems, as well as proper energy and resource pricing mechanisms, said Jiming Ha, chief economist of China International Capital Corp.

Political reforms are needed to facilitate the economic transition, according to Zhiwu Chen, a Yale professor. The state still controls three quarters of the economy, and Chen suggests Beijing should pool state-owned assets into funds and give its people shares to make them feel richer, enticing them to buy.

It is particularly important to enrich China’s villagers because there are 800 million of them, said Chen. Beijing needs to loosen controls on village land and allow farmers more freedom to transfer their land rights to offer them more wealth.

“China needs to act as aggressively as possible to boost consumption to replace exports,” said Paul Cavey, an economist with Macquarie Bank. “Structural reforms will help China to grow out of this crisis.”

TIME TO FREE THE YUAN

China should draw the right lessons from the credit crunch. If it had moved more decisively on the currency front when the international community was clamouring for reforms, its economy may not have been at so much risk now. But some in Beijing seem to be gloating on the other hand that China may have avoided a bullet by not fully integrating itself with market forces.

Fan Gang, an adviser to the central bank, said recently that if China had bowed to overseas pressure three years ago and sharply re-valued the yuan, the result today would have been a steep drop in the currency and possible balance of payments crisis.

Peking University Professor Michael Pettis, however, asserts that China might have been in much better shape today had it revalued the yuan by 10 percent to 15 percent in 2005, instead of the small one-off 2 percent revaluation it carried out. He argues that China would not have racked up such huge trade surpluses and its growth would have been more balanced.

By focusing on selling the yuan to buy dollars to suppress its currency, China has become hostage to its own monetary policy and created massive liquidity at home which contributed to high inflation earlier this year.

After the revaluation and de-pegging of the yuan, the currency hit a peak in September. As China’s export sector has reeled, Beijing has since allowed the currency to weaken a bit.

But it would be unwise to use currency depreciation to increase China’s ability to export overcapacity because that will almost certainly lead to more trade friction — not a good long-term solution.

Instead, Beijing should view the current storm as a chance to regain its monetary freedom.

No one really knows how the yuan will move if the central bank let it trade freely. Just half a year ago, dealers were saying that the yuan would almost certainly rise in the absence of government interference, but now that the Chinese economy is slowing abruptly and exports have fallen in November for the first time in seven years, traders are less certain.

Still, the Chinese economy remains one of the healthiest in the world, so the yuan would be unlikely to depreciate much. That is why Yu Yongding, a former adviser to the central bank, says it’s time for the government to let go and test the real value of the yuan.

To its credit, China has seized the opportunity to launch at least one major reform. After oil prices tumbled, Beijing agreed to allow limited liberalization of domestic gasoline prices and shifted to a much bigger consumer tax, sending a clear signal that consumers would be required to bear more of the future cost of fuel.

But Pettis said that is merely the unwinding of a bad policy and China needs to work on its core problems.

“There is a difference between moving ahead and not moving backwards,” Pettis said. “Now conditions are difficult but the right reforms are almost always done when things are tough.”

– At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund. –