Brazil Memo 1407 - Asymmetric Adjustment

Brazil Memo 1407 - Asymmetric Adjustment

Chamber Member News Post Date: 07/29/13 Source: Projeta Consultoria By: Carlos Geraldo Langoni

In recent years, China worked well as an anchor of world economic growth. China is currently showing signs of deceleration, indicating that its role as a counterbalance to stagnating advanced economies has apparently reached its limits.

· Soft Landing:

Second quarter GDP grew by 7.5%, a weak performance unlike any seen since the late 1990s.

It might appear high, particularly when compared with other emerging countries such as a Brazil. However, this is an impressive drop: China’s growth was around 14% in 2007.

The model implemented since the 1980s, based on exports and investments, is showing signs of exhaustion.

Gross capital formation is growing at a more moderate pace, at around 8%, in contrast to last decade´s 13% average.

Exports are losing momentum, having fallen in June, reflecting weak demand from advanced economies.

· Reform:

It’s not easy to change growth mechanisms “while in flight”. The risks of an emergency landing are palpable.

The government’s strategy is to drive economic growth toward a lower, but sustained, level at around 6%. To reach that goal it will be necessary to increase consumption, which will serve as the new dynamic pole. Leveraging domestic demand through credit, without creating speculative bubbles, is a difficult task.

The inefficiency of the Chinese banking system is certainly a great obstacle. It is made up of a combination of potentially explosive state mega institutions that are vulnerable to political pressures. Moreover, the state banks exist alongside a shadow banking system which operates outside the official regulatory framework.

It is therefore not surprising that this structure is sustaining an exaggerated increase in credit at artificially low rates. Credit already amounts to 200% of GDP.

The timid approach toward liberating interest rates, restricted solely to loans, highlights the scale of this problem: to eliminate the minimum floor of 70% of the reference rate (6%) the Chinese government is focusing on the short term.

Reducing the cost of borrowing, mainly in the public sector, is a dangerous strategy. Although it can generate an extra boost, it does so at the expense of deepening serious macroeconomic imbalances.

· Inflation:

There are two additional restrictions that lie ahead. The transition from an investment to a consumption based model has to be implemented without refueling inflationary pressures – particularly in the sensitive foodstuff area.

At the same time, public and private social security systems should be improved in order to reduce the households’ high propensity Read Full Article