Napoleon Bonaparte may seem an unlikely oracle, particularly in relation to China. But the French general displayed uncanny foresight when he said, "Let China sleep, for when she awakes, she will shake the world." After years of insularity, the People's Republic has spent the last decade looking outwards, and is now the nucleus of a group of growing economies challenging the dominance of the US and Europe. In 2011 and 2012, the world's most populous nation will produce one third of global GDP.
Pillar of strength
David Lubin, Managing Director of Emerging Markets Economics at Citi, explains the importance of China to the global economy: "To have a conversation about the global economy without having China at the centre of it is impossible. Over the past few weeks, the world has become dramatically more China-dependent. With forecasts for growth in Europe and America being downgraded, we're moving into a phase in which the world is resting on this one pillar."
Earlier this year, the IMF predicted that the Chinese economy would outgrow that of the US by 2016 -a forecast which would have been unimaginable twenty years ago. The reasons behind this exponential growth are numerous, but David cites the state's control over the banking system as one of the most important. "After the financial crisis of 2008," he explains, "the state-owned Chinese banking system became an instrument of credit stimulus. The banks massively increased their lending to different parts of the economy.
"For example, they lent huge amounts to local government, which spent the proceeds on infrastructure projects and residential construction, encouraging large amounts of internal consumer spending. This put China in a kind of virtuous circle. The credit extension keeps economic activity levels very high, which in turn increases the quality (the likelihood they'll be repaid) of the loans in the banking system ."
Stick or twist?
Such a system is not without its flaws, though. The extent of the credit stimulus is so huge, it has the potential to create serious imbalances in the economy. If growth slows, the circle could become vicious, as David explains. "For the past few months, China has had much higher inflation than it's comfortable with, which is an offshoot of this credit stimulus. Despite a recent tightening of monetary policy by both raising interest rates and forcing banks to hold more liquidity with the central bank (increasing the minimum amount of cash reserves the banks must hold, thereby making less money available to lend), inflation has remained stubbornly high."
Continued inflationary pressure will eventually start to impinge on consumer purchasing power, which David views as a key ingredient of continued prosperity in China. However, he suggests that over the next year, the Chinese government will be less inclined to intervene, even at the risk of inflation rising even further. "We will soon see a major political transition," he explains, "in the form of a new Standing Committee of the Communist Party, which makes it less likely that growth will be limited. Whether it's an election in a democracy or an administrative transition, as in this case, new policy makers don't like slow growth. The new committee will be faced with a horrible dilemma: for the sake of lower inflation, they need to tighten monetary policy, while for the sake of higher growth, they need to loosen it. Big inflation can be just as uncomfortable politically as a slow growth problem, so which do they tackle?"
Another brick in the wall
It's been ten years since China, joined Brazil, Russia and India in the international acronym "BRICs". All were deemed to be at a similar stage of economic development and were earmarked as the nations most likely to challenge the status quo of dominant world economies. David suggests that nowadays, Russia struggles to earn its place in this group and that there are arguably now other economies emerging with more potential. "I would say Indonesia is the most interesting and under-reported big emerging market story," he says. "It's growing in importance on the global stage, but doesn't get very much attention. It's a commodity exporter like Brazil, but has very low levels of public debt. It's been running a current account surplus for some time and should be considered as being phenomenally strong. It has sensible policy makers, and has benefited a lot from its relationship with China."
The challenges facing Indonesia, though, are those common to many emerging economies. Much of the country's infrastructure is in a poor state, with its roads, ports and transport particularly requiring heavy investment. As well as developing internal infrastructure, countries like Indonesia and China must also nurture their relationships with Europe and the US in order to continue thriving. But America and the eurozone continue to buckle under the weight of debt, and are relying on the emerging markets to keep growing rapidly and provide markets for their exports. David explains how he believes the two groups should work together for mutual economic benefit.
"If the emerging markets are to coexist on these fronts with the developed markets," he says, "they need to allow an appreciation of their currencies." Certain emerging markets, particularly China, have been purposely devaluing their currency, making their exports less expensive for foreigners to buy and imports more expensive for domestic customers. Some have also been reluctant to allow speculative trading of their currencies, which could leave them open to overvaluation. With developed economies keen to cut debts through exports and emerging economies keen to boost trade relations, they may have to meet in the middle. "What's clear," says David, "is that in order to achieve global rebalancing and more rapid resolution of the developed world's debt problem, coordination is required."