China: Not yet the world’s
locomotive
􀂄 Large policy stimulus, but modest impact on world growth
China recently announced changes and additions to its huge fiscal plan while at
the same time pledging to keep up its monetary and financial stimulus measures.
While economic growth has probably slowed further in Q1, policy activism
supports hope that real GDP growth will pick up in the second half of the year.
Given that the government will boost post-earthquake reconstruction and
infrastructure investment, basic industries are likely to benefit, and imports of
materials will probably recover. However, the impact of each additional point of
GDP growth on the rest of the world will be probably smaller than in recent years,
as imports of capital equipment will probably keep falling as the manufacturing
industry experiences excess capacity. On the inflation front, with spare capacity
and unemployment rising, China is back to being a source of deflation, we think.
Only a gradual rebalancing of China’s growth model
Given a relatively low ratio of government debt to GDP, China has the capacity to
aggressively stimulate the economy fiscally. In due course, this should cushion
the negative impact of the global downturn – an impact that was borne out by a
steep fall in exports and FDI inflows. Our economists believe that the official 8%
growth projection for this year can still be achieved thanks to a shift from foreign
to domestic demand. This shift is likely to be gradual, however – in fact they
describe it as a transition. To be sure, more rapid rebalancing would require an
additional rise in ‘welfare’ spending (so as to bring down precautionary savings)
and a degree of exchange rate appreciation that the authorities are not prepared
to effect at this stage.
Exchange rate policy unlikely to change materially for now
Recent comments by top Chinese officials suggest that they are increasingly
uncomfortable with the accumulation of foreign assets (notably US Treasuries and
agencies) that results from the balance-of-payments surplus and the targeting of
the renminbi exchange rate. At the same time, however, the Chinese premier,
Wen Jiabao, has clearly indicated that foreign exchange policy continues to aim
for ‘stability’ in the exchange rate – which in turn means that China is still loathe to
see the renminbi appreciate strongly and will continue to run a balance of
payments surplus and to accumulate foreign assets, albeit at a slower pace.
Moving from dollar to SDR as a way to maintain stability
Recent remarks by People Bank of China Governor Zhou Xiaochuan arguing that
the SDR should replace the dollar as the leading reserve currency should be read
along the same lines, in our view: China expects to continue running BOP
surpluses but wishes to diversify away from the dollar given the turn that US
policy has taken in the face of an unprecedented crisis. Furthermore, China wants
to assert its growing economic weight in global affairs, albeit with characteristic
prudence and gradualism. A new global currency would precisely serve that
purpose. Does US Treasury Secretary Geithner agree or disagree?

Contents
Theme of the week: China 3
Not yet the world’s locomotive 3
China in transition 9
China’s growing bond market 17
Weekly economic updates 19
US: awaiting stimulus arrival 19
Canada: QuiEtly 21
Euro area: to cut, but not to ease? 23
UK: Corporate bond purchases begin 25
Japan: February trade - still dark but some silver lining27
Australia: RBA optimistic on housing 29
EM Asia: will Asian exports stabilize? 31
EEMEA: Turkey likely next at IMF 33
Latin America: taking the trade temp 35
Global economic calendar 37
Global economic forecasts 38
Monetary policy forecasts 40
Global FX forecasts 41
RC