October 21, 2012 / 9:11 PM / 8 years ago

Analysis: Defying doomsayers, China to avoid Japan-style bubble

TOKYO (Reuters) - China has defied doomsayers who have warned for years that Asia’s biggest economy would soon suffer a Japan-style boom and bust. It will continue to defy them for years to come.

The words "Yuan" and "Yen" are seen on on Chinese and Japanese banknotes in this picture illustration taken in Tokyo in this May 29, 2012 file photo. REUTERS/Issei Kato/Files

At first glance, some major similarities between their economies stack up. Just like Japan three decades ago, China is under pressure to let its currency rise, boost domestic consumption and grow its services industry to cut reliance on exports and investment.

A slide in economic activity for seven straight quarters and a view among analysts that growth could be closer to 5 percent by the end of the decade than the near-10 percent it has averaged for the last 30 years, has revived concerns that Beijing faces a Japan-style battle with stagnation.

But analysts say China is hardly a Japan in the making.

Abundant room for greater consumption and wealth, a slow-rising currency, and steps to cool property markets will leave it in good stead to avoid Japan’s fate.

“I know as a matter of fact that policymakers in Beijing have looked a lot at Japan,” said Louis Kuijs, a former World Bank economist now at the Royal Bank of Scotland. “Japan often comes up in discussions.”

Whether China succeeds in avoiding an economic crash depends on how far it can turn its maturing, export-driven economy into one more geared to services and domestic consumption, a transition the World Bank says must happen well before 2030.

Beijing would also have to replace central planning with a market-driven growth model.

If the transformation struggles though, the biggest risk is that China falls back on the housing market for growth, said Tomo Kinoshita, chief economist at Nomura Securities.

That could lead to a bubble and bust in what is already a frothy market. Sky-high property prices were a major factor behind Japan’s economic bust.

Since property accounts for more than 13 percent of economic activity in China and fuels more than 40 industries, it is a tempting crutch for policymakers.

China’s usually reticent central bank acknowledged the policy quandary at an International Monetary Fund meeting in Tokyo this month.

It is a “delicate situation”, Deputy Central Bank Governor Yi Gang told a financial forum. On the one hand, housing is a crucial driver of growth, but on the other hand it should be kept stable.


The strongest argument why China’s economy will avoid Japan’s fate is that it has plenty more room to grow. HSBC believes it could be another decade before momentum runs out from Beijing’s 1978 big-bang reforms, when China started to open up its economy to market forces.

Despite having grown an average 10 percent for 30 years, China is still years behind pre-bubble Japan.

“If the country is poor and catching up, it can grow out of problems easier,” said Kuijs.

China’s per capita GDP last year was $5,445, about that of Japan’s in 1963, World Bank data adjusted for price changes showed.

When Japan’s economy crashed in 1990 and began its “lost decade” of economic stagnation, its per capita GDP was the equivalent of $43,000 in 2011 terms.

“In the medium-term, China is still a developing country and many people will want to have more things - TVs, cars etc,” Takehiko Nakao, Japanese vice finance minister for international relations, told Reuters in a recent interview. “China is still at an early stage to bump into a wall of constraint to growth.”

Some say Japan’s biggest error was to allow an economic bubble to form by leaving interest rates too low for too long. It prolonged the pain by delaying a mop-up of its bad debt.

The yen gets blamed too, again, for different reasons. Those in the West say Japan was too slow to let the yen rise as the country’s economy grew quickly.

Beijing, on the other hand, thinks Tokyo erred by caving in to foreign pressure to let the yen rise too fast, too far.

The yen’s nominal effective exchange rate, or its trade weighted exchange rate, leapt 57 percent in the three years after Tokyo signed the Plaza Accord in 1985 with the United States, Britain, West Germany and France to push the dollar down and reduce the U.S. trade deficit.

By the time Japan’s economy began wobbling in 1990, the yen had retreated but was still up around 30 percent in trade weighted terms in five years.

In today’s China, exporters are the loudest opponents of Beijing’s long-term plan to let the tightly controlled yuan trade more freely, fearing it will crimp their competitiveness and lead to a Japan-like economic slump.

Indeed, Beijing has allowed the yuan’s nominal effective exchange rate to climb at a less intensive pace of 20 percent in the seven years since it revalued the currency against the dollar in 2005.

Beijing now says the yuan is near an equilibrium level, adding to stock phrases that the currency must be “basically stable” and any reform “gradual.”


Mindful of criticism that the Bank of Japan over-compensated for a firm yen when it cut rates five times between 1985 and 1989, analysts argue China has been more vigilant on monetary policy too.

It has been more aggressive to raise interest rates when the economy is doing well, but resisted pressure for aggressive cuts when times were bad.

It lifted rates five times between 2010 and 2011 as China’s economy recovered from the global financial crisis. When activity cooled this year it reversed policy with two rate cuts, but has held its ground since despite market calls for more easing.

Still, China’s house prices are mind bogglingly high, in part because property purchases are one of the few forms of investment available to cash-rich savers in a country where financial markets are underdeveloped.

An IMF paper showed the cost of a 70-square-metre flat in Beijing equaled about 20 annual household disposable incomes in 2010, less than Hong Kong’s 24, but far dearer than Tokyo’s 10 and the United Kingdom’s 4.5. Across China, the average is 4.5.

Fearing a backlash over steep home prices from ordinary Chinese, Beijing has promised not to relent on making it hard or impossible for savers to buy second or third homes to snuff out any bubble.

But some fear Beijing’s fortitude won’t last, especially if it brings about slower economic growth, a decision made more painful by the cooling of the global economy.

According to Bank of Japan Deputy Governor Kiyohiko Nishimura, China is already nearing a “danger zone” where property bubbles can spark a financial crisis.

Property bubbles in the United States and Japan popped after loans and working-age populations peaked. China’s working-age population is close to peaking, Nishimura wrote in a paper in August.

“It is extremely difficult to persuade people who (want to) believe ‘this time is different’ and are convinced they are now on the foothills of eternal prosperity, just as long as their path is not blocked by some stupid policymaker,” he wrote.

Additional reporting Tetsushi Kajimoto and Tomasz Janowski in TOKYO; Editing by Neil Fullick

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