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REPEAT: MNI INTERVIEW: Pettis: Pay Less Attention to China GDP

Repeats Story Initially Transmitted at 06:48 GMT Oct 26/02:48 EST Oct 26
--Urges Caution on Opening Capital Account
     BEIJING (MNI) - Investors should pay less attention to Chinese GDP growth
data as it may not reflect actual economic conditions in the country, China
expert Michael Pettis told MNI in an exclusive interview.
     Pettis also argued that China needs to be very cautious before making any
decision to open up its capital account.
     Pettis, a well-respected economic theorist and financial strategist, is now
a professor of finance at Guanghua School of Management at Peking University in
Beijing. He was one of the first analysts to warn of the need for China to
change its growth strategy, the topic of his well-regarded book "The Great
Rebalancing," published in 2013. His China Financial Market Blog is also widely
read.
     China's National Bureau of Statistics announced last week that Chinese GDP
grew 6.8% year-over-year in the third quarter, slightly lower than the growth
rate of 6.9% in the first two quarters of the year, but strong enough to
increase many investors' confidence in the outlook for the Chinese economy.
     However, Pettis argued that short-term fluctuations in the GDP figures
likely don't reflect actual growth. 
     In China, GDP is an input into the economic system, not an output, he
noted, and so doesn't provide the necessary information on the state of the
underlying economy.
     "Consider the example of building two bridges: one is a bridge to nowhere
and the other is a useful bridge. They both enter into the GDP data in exactly
the same way," Pettis said. "The way we get the reported data to conform to the
true economic value of the bridges in a market economy is to write down the
first bridge, as it creates no economic value, and then when we record the
associated loss in the GDP calculation, it reduces reported GDP."
     "This mechanism is what ensures that reported GDP growth broadly matches
the underlying performance of the economy. But if this mechanism is eliminated,
as it seems to be in China, then they no longer match," Pettis said.
     The implication is that there will be a gap between the nominal GDP figure
and the actual GDP number, the size of which depends on the extent of
inefficient investments, he continued.
     That Liaoning Province admitted it had inflated its GDP figures from 2011
to 2014 and was forced to cut its estimate of 2015 GDP from CNY2.87 trillion to
CNY2.20 trillion, suggests how large this gap can become.
     In addition, GDP growth in China, to a large extent, is a function of
credit growth, because governments have strong incentives to meet the GDP growth
target set by central government each year. For this year, the growth target is
6.5%.
     "There is a natural underlying growth of GDP, which is whatever the economy
is able to create productively, and then there is the GDP growth target," Pettis
said. "If the target is higher than the underlying growth of GDP, the way to
bridge the gap is to allow debt to grow enough to increase economic activity by
whatever amount is needed."
     "When you set a GDP growth target, in other words, you are implicitly
setting a credit growth target. You either have to hit both or neither," Pettis
said.
     This argument can be used to understand the economic impact of the
government's ongoing deleveraging campaign, which some analysts argue will put
downward pressure on GDP growth as the two pillars of recent China growth --
real estate investment and government infrastructure spending -- will both be
contained. And there seems to be some evidence of this in recent economic data.
     Real estate investment grew 8.1% year-on-year from January to September,
while property sales, recognized as a leading indicator for real estate
investments, fell 1.5% y/y in September, the first negative growth rate since
April 2015.
     Infrastructure investment grew 19.8% in the January-September period,
relatively unchanged from January-August growth, but it has been trending
downward since the 27.3% growth during the January-February period.
     "It is not possible to constrain overall credit growth without constraining
GDP growth." Pettis said. "If you give up the GDP growth target, you can rein in
credit growth. If you don't, you can't."
     "In the past five years, there has been a lot of talk about reining in
credit growth, but [the government] has never been able to do so. And I don't
think that's an accident," Pettis continued. "It remains to be seen whether
things will change."
     NOT THE RIGHT TIME TO OPEN CAPITAL ACCOUNT
     Recently, the prospect that China could soon open up its capital account
has become a heated topic, and some officials have said a window of opportunity
now exists to accomplish the goal. People's Bank of China Governor Zhou
Xiaochuan said as much in an interview with Caijing magazine on Oct. 1,
stressing that if reform is not carried out now, the costs of doing so in the
future would be even higher and the process more difficult.
     However, Pettis suggested that China needs to remain cautious about finally
opening up the capital account, as the costs of doing so could be overly
burdensome.
     "There are liberalizing reforms that make long-term sense, but which under
certain conditions shouldn't be implemented," Pettis said. "To liberalize the
capital account might be good in the long run for China, but it might not be the
right time to do it because this is a time when you want to reduce the risk of a
financial crisis."
     "Financial crises are always the consequences of asset-liability
mismatches. But because its banking system is largely closed and Chinese
regulators highly credible, they can restructure liabilities at will, making
China unlikely to have a crisis," Pettis said. "However, as you eliminate
capital controls, you open up the system and increase the amount of capital
inflows and outflows for the country."
     Pettis said he was worried that capital inflows would not be in the form of
long-term equity investments, but would be more speculative in nature. "The
problem of these kinds of inflows is that when China is doing well, you'll see
an increase in inflows that will strengthen domestic markets, but the moment
China is doing badly, these inflows will quickly convert into outflows, which
will weaken the domestic market at the worst possible time," he said.
     Pettis is not sure if there is a right time for China to open up its
capital account completely, and wonders whether it is ever the right thing for a
developing country to do.
     "As long as China does not have a resilient enough financial system and the
investor structure remains speculative, China shouldn't open its capital
account," Pettis said. "And nobody knows when China will satisfy both
conditions."
--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com
--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com
--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

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