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Issue 1/14 January 2009

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Today’s Issue Includes:


1) Is GDP falling faster than anticipated? By Nigel Tree

With the UK economy shrinking by 0.6% in the 3rd quarter of 2008, the chancellor in his pre-Budget report of 24th November 2008 forecast a further three negative quarters and expressed a hope that growth would resume in the second half of 2009. He forecasts that growth will be 0.75% in 2008, but that the economy will shrink somewhere between 0.75% and 1.25% in 2009, before recovering to growth of between 1.5% and 2% in 2010. The recent trend can be seen in the figure below.

% Change in GDP


Chancellor’s forecasts already out-of-date?

However, on 10th January the National Institute of Economic and Social Research (NIESR) published their own estimates of the UK economy to show that the downturn was actually starting to get worse. In fact, they estimate the UK economy to have declined by a huge 1.5% in the last quarter of 2008. If this is true, it will have been the worst quarter’s performance by the UK economy in the past 28 years. It will also be the 2nd quarter in a row of economic decline, which will “officially” mean that the UK is in recession.

According to the NIESR: “Since 1955, when quarterly figures were first produced, there have been only five quarters in which output has fallen more sharply, with the lowest figure of -2.6% in 1958.”

The NIESR has a particularly good track record of forecasting GDP changes and they suggest that the likelihood is that their estimate of a 1.5% decline would only be between 0.1 and 0.2% different from the official figure to be published by the Office for National Statistics on 23rd January.

Worsening news on the retail front ….

This pessimistic forecast by the NIESR was backed up on 13th January by the publication of their retail sales monitor by the British Retail Consortium. This showed that like-for-like sales on Britain’s high streets were down by 3.3% in December 2008 compared with the previous year, and total retail sales fell by 1.4%. This was the worst December figure since 1995 when the survey first began.

...but all sectors of the economy are suffering.

The British Chambers of Commerce (BCC) also published their 4th Quarter Economic Survey on 13th January after surveying nearly 6,000 businesses. They say that results from the final quarter of 2008 “…highlight a frightening deterioration in the UK economic situation – they are the worst on record for both manufacturing and services since the survey was first published in 1989.” They went on to say that: “Domestic demand is plunging, exports are falling and confidence is plummeting.”

The BCC called for “a clearly defined National Recovery Plan … involving all politicians.”

The situation is truly bleak and set to become even bleaker.

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2) How is the global credit crunch affecting China? Interview with Paul Ellis, Head of Economics and Business Studies, Harrow International School, Beijing.

Nigel Tree asks the questions.
NT: China has had exceptional growth of over 10% pa over the past 5 years. This is forecast to drop slightly next year but still to remain above 8%. Does this mean that China is immune to the current global credit crunch?

PE: China’s has maintained growth rates at a high level for most of the past quarter century which has transformed its economy. There is much uncertainty about the accuracy of the figures and they could well have been lower in some years but actually higher even than reported figures in recent years. This makes analysis difficult. There have also been arguments put forward about so called decoupling which are taken increasingly less seriously.

Recent evidence seems to indicate a slowing of the of the growth rate. After a period of tightening monetary policy this is now being relaxed. The rise in the value of the Yuan has hit Chinese exports and with exports at 40% of GDP this seems likely to hit growth. This headline figure may over emphasise China’s reliance on imports as many of these are re-exports and the value added figure is substantially lower. The recent announcement of half of all Chinese toy manufacturers going into bankruptcy is one illustration of this.
China’s banking system is even more opaque than that of troubled western banks and there is uncertainty about the exposure to the credit crisis and to domestic defaults from falling property prices and other bad debts. With China’s major export markets of the USA, Europe and Japan going into recession it is difficult to see how these firms will not be affected.

China also maintains a high savings ratio and high rates of capital accumulation. If firms decide to cut back on investment this will reduce growth rates. The last time the global economy entered a period of recession in the early 1990’s China too saw official growth rates fall to below 4%.

NT: The Chinese government has cut interest rates. Although inflation has dropped from 8.7% in February to 4.7% in August, would they have the scope to cut interest rates further if necessary and/or do they have the ability to apply a fiscal boost to the economy?

PE: Inflation rates have fallen over the past year in both food and commodities and this looks set to continue. This has allowed a loosening of monetary policy in terms of both interest rates and reserve ratios.

The government budget surplus and low national debt also gives room for maneuver in terms of a fiscal boost. However, if tax revenues fall as exports are hit this situation could change rapidly. The property markets in China have also shown signs of falling with regional government figures showing greater falls than official central government figures. This could put pressure on China’s banks in the same way that it has in other countries.
Domestic consumption remains low and savings rates high in part due to the lack of a social safety net. The introduction of welfare schemes could reduce this but it is hard to see this having a significant impact in the short term.

NT: The Chinese economy has been very dependent on assembling low value-added goods for export coupled with capital-intensive heavy, and often, polluting, industries. Although productivity has been increasing, do you see China developing in different ways moving forwards?

PE: There is evidence of China moving up the supply chain and many of the low-value added industries have been hit by rising wages and costs coupled with the appreciation of the Yuan. China still maintains a substantial current account surplus but faces some potential difficulties. Transport costs, as shown by the Baltic index, have been rising leading to some shifting of production. China also faces increased competition from rival low cost producers. The concerns over quality and safety have also hit exporters both in terms of sales and costs to improve standards. Domestic concerns over safety and environmental issues are also having an impact.

Over the longer term China is certainly gaining experience in higher value production such as ship building, car production, electronics, aviation, chemicals, etc. This looks set to continue.

China needs to shift to a greater reliance on domestic demand in the future. This shift is likely to see a slowing of the double digit growth rates of recent years. However, it should be remembered than around half of China’s population is officially classified as rural and there is still much of the county that has a long way to go before it can be seen as developed. Of course these figures could well underestimate the migrant population which has already effectively moved to urban centres.

Editor’s Footnote: The OECD published its survey of Composite Leading Indicators on 12th January which showed that these had declined for China by 12.9 points in November compared to a year previously which was indicative of a “strong slowdown” in the economy.

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