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Despite SARS, China Bounces Back
Spending by Consumers and Government Spurs Growth; Worries of a Credit Binge
By Peter Wonacott in Beijing and Karby Leggett in Shanghai
BEIJING -- The Chinese economy appears to have dodged the SARS bullet. But other problems percolating within one of the world's most robust economies could still imperil growth.
Despite SARS, China this week will likely report first-half growth soared more than 8% on an annualized basis, the same pace as for all of 2002. Manufacturing jumped 16.9% in June from a year earlier, according to government figures. Exports expanded 32.6%.
How did China manage such growth despite widespread fears that SARS would damage its racing economy? From November to June, SARS afflicted more than 5,300 people in mainland China -- nearly two thirds of the world's total -- and killed 348 Chinese. Beijing's streets and hotels emptied as people feared mingling in public. After the disease peaked in late April, several Western investment banks lowered their forecasts for the country's 2002 growth by as much as a full percentage point.
Those forecasts have since been adjusted upward again. Continued government pump-priming, SARS-related tax breaks and easy credit by state banks kept money flowing into the economy. Though some businesses, such as restaurants, suffered, companies say that Chinese consumers kept spending for many big-ticket items. SARS even created new demand for cars among people who feared contracting the disease on public transport.
Foreign investors canceled business trips but kept projects on track. Volkswagen AG just announced plans to invest €1 billion (U.S.$1.14 billion) to expand its facilities and build new ones, as part of a drive to more than double car sales in China to one million units by 2007. General Motors Corp. is pressing forward with plans for a new $300 million auto plant near its existing one in Shanghai that will make mid-range sedans. For global auto makers, China's fast-growing market is just too important to slow down.
The disease itself helped ease the economic fallout, fading by last month much faster than many had anticipated.
China's bounceback offers a glimmer of hope for U.S., Japanese and European companies in a generally stagnant global economy. It is especially welcome news in Asia, where China, which accounts for about 4% of global gross domestic product, is emerging as a linchpin of regional growth. Whereas China ran $103 billion trade surplus with the U.S. last year, it had a $68 billion deficit with the rest of Asia, including Japan. China is now the biggest importer of goods from Taiwan and South Korea. If Hong Kong is included, China is expected to become the biggest market for exports in the next couple of years for Japan, Singapore, Malaysia and the Philippines.
To be sure, China's manufacturing juggernaut is likely to continue to put pressure on rival producers world-wide. But for now, the country's bounceback is stirring relief in China and abroad. "As China gets wealthier, their economy grows more, their standard of living rises, and they are going to be a good market for us and for the rest of the world," said Treasury Secretary John Snow at a meeting with Wall Street Journal editors last week.
The Chinese government's proclivity to conceal bad news, as shown during the SARS crisis, has long undermined the credibility of its economic statistics. But several signs, including new upward pressure on prices and booming imports, indicate that demand in China's economy is now picking up. Figures from Chinese customs tend to be reliable, for instance, because it needs accurate data to assess taxes on trade.
China isn't out of the woods. A recurrence of SARS this fall could rattle investor confidence. Mass protests in Hong Kong, initially directed against proposed security legislation, have now mushroomed into an anti-government campaign. Despite tax relief and other breaks, SARS has helped maul China's travel industry, and could erase up to $36 billion in revenue this year, according to a new study by the Tourism Research Center, a think tank associated with Peking University.
The blow to tourism, a sector largely driven by private companies, has aggravated a poor job market. More than one million new graduates are facing unemployment this year, according to China's Ministry of Labor and Social Security, a situation that will not only erode consumer demand but also potentially inject a new source of anger into society.
Most worrisome is China's decision to offset the impact of SARS by boosting government spending. In addition to relying on government bonds, Beijing finances many of its most important national projects with loans from state-owned banks. Over the past year, many banks had already ramped up lending volumes. Now, new lending is reaching an almost unprecedented level. In the first quarter, China's four largest state banks issued $60 billion in new loans, up a whopping 356% from a year earlier.
To some economists, the credit binge recalls the days of easy capital in many Asian countries before the region's financial crisis during the late 1990s. Indeed, as happened to Asia then, a big chunk of the loans flowing from China's banks these days are going into the property market, where prices have soared. Showing concern, China's central bank last month issued a circular calling on banks to adopt more stringent criteria when making loans to real-estate projects.
For the time being, the wounds inflicted directly by SARS seem to have been kept to a minimum thanks to people like 30-year-old Beijing resident Sun Yuanfei. In late April, days after the Chinese government admitted a deadly virus was moving through the heart of the nation's capital, Mr. Sun, a shipping executive, bought a $16,500 VW Bora, a four-door sedan. "I didn't want to die from SARS never having driven a nice car," says Mr. Sun.
Mr. Sun wasn't alone. Auto buying soared as Chinese sought to avoid crowded busses and trains. China's output of passenger cars jumped 90% in May and 83% in June, from year-earlier periods, as suppliers rushed to meet new demand.
"When SARS hit in China many of us became concerned that it would impact this [vehicle] growth rate," said J.T. Battenberg, chief executive of Delphi Corp., the world's largest auto parts supplier. "I think it did impact this growth rate but in a very positive way."
Consumers appeared to bolster the economy in other unexpected ways as well. For example, as the number of SARS deaths rose, Mr. Sun and his wife canceled a May vacation and, like millions of others, locked themselves indoors. Tired of bickering with his wife over television channels, Mr. Sun rushed out to buy a second TV. "It was a harmonious solution," he said.
Door-to-door sales also gained. Mary Kay Inc., a private, direct seller of cosmetics, worried the health scare would impede its army of 100,000 salespeople in China. Instead, sales took off, as consumers avoided crowded shopping centers and turned to Mary Kay for telephone orders and shopping in more private settings, according to Mary Kay executives.
"Our numbers continue to be nothing short of fantastic," says David Holl, Mary Kay's president and chief operating officer. Revenues in China through June are up 60% from a year earlier, he said. They are projected to exceed $100 million this year.
In the early days of the SARS outbreak, American International Group Inc. fretted, too, that SARS might prevent insurance agents from visiting prospective customers. But an AIG salesman in Beijing, Bu Weibin, said he was soon getting calls from people who had suddenly become interested in life insurance as the epidemic widened around them.
"People wanted to meet, but they were scared," he says. Before every house call, Mr. Bu would spray his suit with disinfectant. Upon arrival, he wore a surgical mask and asked permission to wash his hands in a sink.
Wal-Mart Stores Inc., which spends $12 billion on Chinese products a year, curtailed travel by its buying representatives in China. But the big retailer kept its supply pipeline open by flying Chinese factory representatives to the U.S. and continuing to place orders.
Many foreign companies say they did experience a sales slowdown in China as Chinese postponed travel and stayed away from stores due to SARS. Among these, Eastman Kodak Co. said film sales slowed in line with a drop off in travel. Chip-maker Advanced Micro Devices Inc. and several telecommunications companies said they suffered as people avoided purchases of cellphones and other electronic goods.
Since Beijing was taken off the World Health Organization's list of places affected by SARS June 24, signs of pent-up consumer demand are appearing. Swedish furniture group IKEA says sales at its Beijing store have rebounded sharply. So far this month, sales are up 20% from a year earlier, said an IKEA spokeswoman in Beijing.
For many multinational companies, the fading of SARS seems to have brightened China's promise. In late June, Anheuser-Busch Cos. doubled its stake in China's Tsingtao Brewery Co. On Friday Wal-Mart opened a nearly 200,000-square-foot Sam's Club store in a suburb of Beijing.
Two of Japan's top carmakers, Honda Motor Co. and Nissan Motor Co., said earlier this year that they would delay launching new vehicles for China after they pulled dozens of Japanese engineers stationed there back to Japan during the peak of the SARS outbreak. But when the epidemic faded last month, Japanese engineers rushed back to China. Both companies still plan to meet goals to double output in China by next year.
Local Chinese businesses were helped by big tax breaks. In Shanghai, which had only a handful of confirmed SARS cases, the city reduced the tax rate by half for restaurants and waived it altogether for some of the smallest mom-and-pop shops. The impact was immediate.
"Lowering our taxes was a big help," says Wu Weiling, general manager at Yi Jia Yi, a noodle shop in downtown Shanghai, saving her business at least several hundred dollars a month. While that may seem like a small number, the savings were enough to allow Ms. Wu to keep her staff intact.
All during SARS, China's government-sponsored building frenzy continued apace, as President Hu Jintao and Premier Wen Jiabao quickly staked their reputations on repairing the political and economic damage from SARS.
In Shanghai, construction raced ahead on a big new bridge, along with a deep-water port and an underwater tunnel. The new, $300-million Lupu Bridge -- which spans 2.4 miles across Shanghai's Huangpu River -- was completed several weeks in advance. It opened last month, with Yao Ming, the Chinese basketball star, leading an inaugural jog across it.
This massive building effort was mirrored across China. Sluice gates on the $22 billion Three Gorges dam project were closed, allowing the reservoir to fill. Construction on the $48 billion South-to-North Water Transfer Project continued. And the $18 billion West-East natural gas pipeline and hundreds if not thousands of other smaller projects all moved ahead.
But while such projects helped offset the slowdown caused by SARS, economists fear it could also create trouble down the road. Much of the investment is coming from government bonds and loans issued by state-owned banks -- at a time when growth in China's budget deficit has soared to record levels. Last year, government-driven fixed-asset investment accounted for 42% of China's GDP, up from 34% in 1997, according to Yi Ping Huang of Smith Barney in Hong Kong. In the U.S., the figure is about 17%.
For China's financial institutions, there is a more immediate concern. The country's four big state-owned banks already hold non-performing loans that Standard & Poor's estimates could exceed $500 billion. That pushes the banks' liabilities to a level greater than their assets, the credit-rating agency said. Analysts are concerned that soaring new loan issuance may be laying the groundwork for a future banking crisis in China.
During the first five months of this year, China`s banks issued some $152 billion in new loans, more than double the amount of credit issued during the same period a year earlier, according to Nicholas R. Lardy of the Institute for International Economics in Washington. According to Standard & Poor's, outstanding credit in China is now equal to 138% of GDP, up from 88% in 1995, and above levels S&P considers safe in other countries. This suggests that "credit is being directed toward unproductive or under-productive activities," S&P said in a recent report.
-- Jon E. Hilsenrath in New York, Todd Zaun in Tokyo, Shawn W. Crispin in Bangkok and Michael M. Phillips in Washington contributed to this article.
Write to Peter Wonacott at peter.wonacott@wsj.com and Karby Leggett at karby.leggett@wsj.com
Updated July 14, 2003
STILL COMING
SARS did little to deter the multinational push into China.
June 18: Honeywell says it moved Asian headquarters to Shanghai from Singapore, estimates revenue from China operations will hit $1 billion by 2005.
June 23: AOL Time Warner invests $1.7 million in Shanghai movie complex.
June 27: Anheuser-Busch doubles stake to 9.9% in China's Tsingtao Brewery.
July 1: Japan's Daiwa Securities to set up brokerage joint venture in China.
July 4: Mary Kay says it is considering investment in a new plant in Hangzhou.
July 7: Volkswagen announces $1.14 billion investment plan to expand facilities and build new ones.
July 10: Morgan Stanley announces $90 million property investment in Shanghai.
July 11: Wal-Mart opens first outlet in Beijing.
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