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A penny saved may be a penny earned, but in China a penny saved is
usually invested in an infrastructure project or an increase in
manufacturing capacity. China’s gross domestic savings rate, after
averaging 40% or so of GDP for most of the 1990’s, has grown over the
past couple of years to close to 50% of GDP. This is an unprecedented
number, and while a portion of this saving has been invested abroad in
US Treasury bonds – thus funding the US current account deficit and
keeping US interest rates low – the vast majority has been invested in
the domestic Chinese economy. Gross capital formation was around 45% of
GDP last year, and it powered an economic expansion that saw GDP rise
by 9.5%.
A penny saved may be a penny earned, but in China a penny saved is
usually invested in an infrastructure project or an increase in
manufacturing capacity. China’s gross domestic savings rate, after
averaging 40% or so of GDP for most of the 1990’s, has grown over the
past couple of years to close to 50% of GDP. This is an unprecedented
number, and while a portion of this saving has been invested abroad in
US Treasury bonds – thus funding the US current account deficit and
keeping US interest rates low – the vast majority has been invested in
the domestic Chinese economy. Gross capital formation was around 45% of
GDP last year, and it powered an economic expansion that saw GDP rise
by 9.5%.
So where exactly is
all this Chinese saving coming from and where is it going? Household
savings rates in China, while high, do not explain the nations’ high
savings rate as a whole. As the following chart from the IMF’s World Economic Outlook
shows, high savings rates among enterprises, in the form of retained
earnings, and a high public savings rate have been driving Chinese
savings and investment.

Here’s how Louis Kuijs of the World Bank explains the role of the Chinese government:
Government
saving is remarkably high compared to other countries, and is much
higher than suggested by the headline fiscal data. It reached 7.5
percent of GDP in 2001 (it is assumed to have remained roughly at that
level in 2002-03). As a result, the government runs a significant
saving-investment surplus, which forms an additional financing source.
Indeed, in addition to its own investment, the government finances
investment via capital transfers to state-owned enterprises in the
power, electricity, water, transport, andother infrastructure sectors.
The transfers were 6.2 percent of GDP in 2001 and are assumed to have
remained at roughly that level in 2002-03. Investment by enterprises
established by the government financed by capital transfers could be
seen as adding to overall public investment.
Interestingly,
China has been running budget deficits even as public sector savings
have been increasing. How can a fiscal deficit, which by definition is
government dis-saving, magically turn into excess savings? Chinese
financial and economic statistics are often more akin to a riddle
wrapped in an enigma than they are to the gospel truth. That said, it
appears as if public investment in physical infrastructure projects are
being counted as savings. If anyone has a good explanation as to these
accounting dicsrepencies, we would like to hear it. The following chart
tracks the increase in China’s public deficit.

In
any event, Chinese investments have thus far been successful in
providing high growth rates. But China may have a hard time making the
adjustment from an investment and export led growth strategy towards a
more balanced, consumption-oriented economy. For one, much Chinese
investment has been funded through either capital transfers from the
state or through the retained earnings of enterprises. As these
investments have not undergone any financial intermediation through the
banks or capital markets, it means that no one has been doing their due
diligence. Normal accounting standards and profit motives are not
necessarily driving investment decisions. These investments may prove
successful in the long term – or they may not, nobody really knows. It
is likely, however, that a large proportion of these investments will
result in over capacity.
Chinese investment flows have been
especially heavy to the following sectors: infrastructure, aluminum,
steel, autos, cement and real estate. If, say, the real estate sector
finds itself substantially overbuilt, that could lead to job losses in
the construction industry. But since its legitimacy is largely based on
providing continued economic growth, China’s government is very
sensitive about unemployment, especially as it is engaged in an ongoing
restructuring of the SOE sector.
So if China becomes plagued
by over-capacity in non-import competing sectors, it will lean all the
more heavily on exports as an engine of job creation. If it faces over
capacity in the export sector, it will likely dump the excess capacity
onto the global markets rather than allow substantial job losses that
could threaten social stability. Moreover, while China is making
efforts to modernize its financial system and increase the role of the
capital markets, these efforts will take some years to bear fruit.
Eventually, efficient bond markets could both allow corporations to
fund expansions through borrowing and provide the discipline necessary
to avoid uneconomic investments. Increasing consumer access to credit
could reduce the current reliance on savings to finance big household
purchases.
But until then, it will be hard for China to take
part in any major restructuring of the global savings imbalance. China
will need to consume more and save less - just as the US must get its
fiscal house in order - in order to redress the imbalance. In the
meantime, lets hope that the mandarins directing investment in China,
and not least Chinese President Hu Jintao, know what they’re doing.
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