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Chinese Economy Will Grow Faster Than Expected; Investors Urged to be Cautious

Press release from the issuing company

Feb. 17, 2004 -- China’s economy will register growth in the 10% to 12% range this year, up from 9.1% in 2003, but investors in the Chinese boom are urged to proceed cautiously, according to a report from The Conference Board released today. China’s growth is being heavily driven by rapid investment growth. Gross capital formation has expanded at an average annual rate of 12% in the last three years. Investment accounts for more than half of total economic growth in China, compared with 25% to 35% in most advanced economies during good economic times. “China has become a magnet for global investment because it is a major global growth driver,” says Gail D. Fosler, Executive Vice President and Chief Economist of The Conference Board, in the latest issue of StraightTalk, a newsletter prepared for Conference Board member companies. “But it must be understood that it is an emerging market, experiencing many of the usual growing pains. The region’s rapid growth rate, which likely will be reduced sharply by either the Chinese government’s own efforts or external pressure from higher interest rates and increased global competition for capital, or both, will prove important over the next few years.” Tips for Business Investors Government spending in China, which had dropped to 12% of Gross Domestic Product, is also accelerating—now back to almost 14%. GDP growth averaged 7% in the past 5 years, with government spending rising at a 10% annual rate. Heading into the 2008 Olympics, upward pressures on government spending will intensify. “Business investors in China would do well to extend the time horizon for investment paybacks and/or raise the discount rate for unforeseen risks,” concludes Fosler. “China is still a very attractive market, but caution in near-term expectations will help to prevent disappointments later, when, if history repeats itself, the Central Bank will raise interest rates.” China’s current rapid growth rate is likely to be viewed by Chinese policymakers as a potential source of instability—a condition they seek to avoid at all costs. What is unknown is how these rapid economic growth rates will react to the combination of domestic policy restraint and potential increases in global rates—a new feature in the Chinese economic scene. Overall investment in China has grown from about 30% to more than 40% of the total economy, while the consumer share has dipped from 50% to about 47%. In contrast to many other emerging markets, or advanced economies, the consumer sector has at least to date played a less important role in China’s growth. One consequence is that China is potentially very highly leveraged with respect to investment spending. This leverage means a given change in the investment growth rate has a relatively large impact on the economy; and more volatility into the economy because investment is itself inherently volatile. Since it is difficult to continue to invest rapidly year after year and sustain high economic returns, diminishing returns will set in, with noneconomic projects replacing economic projects, and asset quality in the banking system deteriorating. The Importance of Foreign Investment Foreign investment plays a definitive role in China’s investment/business environment. China has succeeded in attracting $40 to $50 billion a year in foreign direct investment from 1985 to 2003. It is difficult to overstate the importance of foreign investment on the Chinese economy. While private Chinese firms are emerging all the time and large private firms like Haier are well known globally, much of China’s current economic activity is driven by foreign firms either investing directly or developing production/supply partnerships. Consumer spending in China is held back because employment is not growing rapidly and income distribution is very uneven geographically and among income groups. Overall, China has added about 90 million jobs since 1990—about 7 million per year. But with total employment in China estimated at about 740 million, this increase represents only about 1% per year. Also, the large gaps between urban and rural incomes concentrate income in a relatively few households. China’s small consumer sector adds to the cyclical vulnerability of the Chinese economy.