“There’sa broad consensus in Beijing that what has worked very successfully fornearly three decades will not work going forward. And while the economycertainly performed very impressively last year, there is a growingsense of concern in official China that may not be the case for muchlonger.”
That was Morgan Stanley (MS) economist Stephen Roach’s message toinvestors in Hong Kong last week in the wake of his latest foray toBeijing. Roach, one of Wall Street’s best known analysts and a frequentpilgrim to the Middle Kingdom, emerged from five days of meetings withsenior Chinese policy makers convinced the nation’s communist leadersare about to take radical steps to limit the social and environmentalcosts of breakneck economic growth.
Beijing has paid lip service to those problems in years past. ButRoach, one of a handful of Western economists invited to participate inthe China Development Forum,an exclusive annual policy conference organized by the research arm ofChina’s State Council, says discussions at this year’s conclavepersuaded him that now the leadership “really means business.”
Roach offered odds on a Chinese policy turn at a jam-packed lunch for Morgan Stanleyclients. The group, about 200 strong, included many skeptics. ButRoach, among the surliest bears on The Street these days, is alwaysworth a hearing. He declared the collapse of the U.S. sub-primemortgage industry the “functional equivalent” of the dot-com bust - anda harbinger of U.S. growth slowing to 1% or even zero by the end ofthis year. He warned that oil-rich nations in the Middle East havestopped recycling their petro-dollars and are focusing instead oninternal development. He argued that globalization has proved a rawdeal for workers in the developed world, raising the politicalpressures for protectionism.
“I am worried that politicians who have a long history of doing dumbthings are about to do dumb things again, especially in Washington,” hesaid.
China plays a central role in Roach’s grim global scenario. As itstrade surplus with the U.S. swells, Roach argues, China has become anirresistible scapegoat for the new, pro-labor U.S. Congress.Conciliatory gestures by the new Treasury Secretary, Roach says, haveonly made things worse. “Hank Paulson brings all these people in fancyjets to Beijing for a strategic economic dialog with China. They haveall these meetings in the state guest house, with fancy banners –‘win-win,’ ‘peaceful rise.’ And they go back with nothing except anagreement to talk again, which further inflames the Congress.”
Roach told investors he was struck by the frankness with whichChina’s top leaders - particularly premier Wen Jiabao - acknowledgedthat previous efforts to control the nasty side effects of thehigh-growth model had failed. He deemed it significant that, in hisnews conference following this month’s National Peoples Congress andremarks days later to the China Development Forum, Wen enumerated themany defects of the current growth model. Among them: over-reliance oninvestment and exports, widening gap between rich and poor, soaringdependence on foreign oil and worsening environment.
It’s no accident, Roach added, that theme for this year’s development forum was “China: Towards New Models of Economic Growth.”
Roach’s bottom line? Forget the impressive GDP numbers. Wen andother Chinese leaders fear their economy is hurtling out of control. Atthe development forum, Roach said, Wen inveighed against “The Four‘Un’s’”: an economy that is unstable, unbalanced, uncoordinated andunsustainable.
“If a year from now I go back to the China Development Forum and theeconomy has turned in another year like 2006, this will be bad news forPremier Wen’s credibility as a leader and manager of the economy,”Roach said. “I don’t think he will allow that to happen.”
It’s almost impossible for foreign scribes to parse the intentionsof top Chinese policy makers like Wen. His public appearances arecarefully scripted. He doesn’t grant interviews. Unlike hispredecessor, Zhu Rongji, Wen rarely meets with foreign experts orexecutives. His appearance at the China Development Forum, launched byZhu in 2000, affords a rare opportunity for outsiders to interact withWen and other key economic officials directly and in a relativelycandid manner. In addition to Roach, other foreign participants at thisyear’s gathering included former HSBC (HBC) chairman John Bond, BP’s(BP) John Browne, former AIG (AIG) CEO Maurice Greenberg and formerWorld Bank economist Joseph Stiglitz. But good luck trying to get themto talk about the conference on the record…
After his speech to Morgan Stanley clients, I rode with Roach out tothe Hong Kong airport to learn more about his impressions. A fewhighlights:
CTD: If Beijing has tried and failed to rein inunhealthy growth for more than three years, what can it possibly dodifferently now?
SR: Well, one problem a lot of investors have with China is thatthey get hung up on fiscal and monetary policy. This isn’t an economylike the U.S. where that’s the only way to judge whether or not thegovernment is tightening.
CTD: So what should we watch?
SR: The planning ministry, the National Development and ReformCommission, headed by Ma Kai. I think the only way China can arrest theinvestment dynamic is for the NDRC to really go at it on aproject-by-project basis. The criteria for all new investments now aregoing to tilt to greener projects, lower energy intensity, lower carbonemissions. I think you’re going to see a lot more serious scrutiny ofthe over-heated sectors like steel, aluminum, cement and buildingmaterials.
CTD: If I’m a foreign multinational or equity investor, should I worry about all this?
SR: If you’re a long-term investor, no. I see a re-balancing of this kind as a constructive development.
CTD: A year ahead of the Olympics, do you really think they’ll hit the brakes?
SR: Stability is a code word in China. When the second-most-powerfulguy in the party stands up in front of the whole country and declaresthe economy unstable, hey, that’s a very serious signal.
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