China's Rescue Plan May Also Bolster World Economy

By David Tweed

Nov. 11 (Bloomberg) -- China's massive effort to shore up its domestic economy may also do the world a favor.

``Very few countries are going to match this stimulus -- it's huge,'' said Nicholas Lardy, senior fellow at the Peterson Institute for International Economics in Washington. ``It's a very strong step and puts them in a commanding position in setting an example to other economies.''

The $586 billion stimulus package, announced on Nov. 9, pushed the price of copper and silver higher yesterday and sent stocks soaring from Hong Kong to Frankfurt. The reaction was a sign of global dependence on the $3.3 trillion Chinese economy, which accounted for about a quarter of world growth last year and consumed 41 percent of coal production.

The global financial crisis and resulting collapse in demand has led to a contraction in Chinese manufacturing and a slump in exports. In addition to propping up domestic industries, the measures may give the world a cushion as the U.S., European and Japanese economies shrink.

The 10-point plan allocates money for affordable housing, rural infrastructure, railways, power grids, social welfare to raise incomes and rebuilding after the May 12 Sichuan earthquake. China will also allow tax deductions for purchases of fixed assets such as machinery to stimulate investment. The plan didn't detail how much would be spent on each area nor how much of the spending had already been announced.

``This broad-based fiscal stimulus program will emerge as the government's front line of defense against an excessive economic slowdown,'' said Jing Ulrich, chairwoman of China equities at JPMorgan Chase & Co. in Hong Kong.

G20 Meeting

The pledge came as leaders from the Group of 20 nations, which includes China, prepare to meet for crisis talks in Washington on Nov. 14 and 15. Finance ministers from the group, meeting last weekend in Sao Paulo, called for interest rate cuts and an increase in government spending to alleviate the economic and financial crisis.

``China showed the G-20 with this package that it is a big player in the world economy, capable of contributing to global economic stability,'' said Carl Weinberg, chief economist at High Frequency Economics in Valhalla, New York, in a Nov. 10 note.

China may cut interest rates again after three reductions in the past two months, central bank Governor Zhou Xiaochuan said after the package was unveiled. He's got extra room to move. Inflation cooled to 4 percent in October, the weakest pace in 17 months, the government said today.

`Ample Liquidity'

A new, looser monetary policy suggests ``that money supply will increase, liquidity will be ample, or interest rates on bank loans will be lower,'' Zhou told reporters at a meeting in Sao Paulo to prepare for the G20 summit.

The central bank said yesterday on its Web site it will strengthen ``guidance'' so that bank lending goes to key projects and smaller businesses.

China's largest banks, with 4 trillion yuan ($486 billion) of cash, have resisted government efforts to boost lending to 42 million small and medium-size companies that drove the economic boom of the past decade.

``It is clear that aggressive fiscal stimulus is necessary to jumpstart the economy at a time of sharply deteriorating outlook and sentiment,'' said Wang Tao, an economist at UBS AG in Beijing. She called higher bank lending ``critical to sustain corporate investment needs.''

China's Stocks Jump

The ripple effect of the plan showed immediately on world markets. China's CSI 300 Index of shares closed 7.4 percent higher, the biggest increase in seven weeks. It added another 1 percent as of 11:30 a.m. today.

Copper gained as much as 8.4 percent in London yesterday, and the MSCI Asia Pacific Index of shares and some Asian currencies also climbed.

In Europe, mining companies BHP Billiton Ltd. and Rio Tinto Group jumped more than 8 percent. National stock indexes gained in 16 Western European nations and fell in two, Austria and Spain.

In U.S. morning trading, Caterpillar Inc., the world's largest maker of bulldozers and excavators, rose as much as 6.3 percent and Freeport-McMoRan Copper & Gold Inc., the world's largest publicly traded copper producer, gained as much as 11.5 percent on optimism about Chinese construction spending.

``The stimulus here was 1 percent of GDP, and there, it's 16 percent of GDP,'' said Bruce McCain, chief investment strategist at Key Private Bank in Cleveland, which manages $30 billion. ``It is a big deal and therefore is a note of optimism especially for the global economy. And we're all hopeful that it will help U.S. stocks as well, especially raw materials.''

Crucial for Commodities

Booming demand in China spurred six straight years of gains for the UBS Bloomberg Constant Maturity Commodity Index, a gauge of 26 raw materials. The Asian country is the world's biggest metals buyer and the second-largest consumer of oil. Spending to expand Chinese railroads, electric grids and housing helped to more than quadruple the price of copper and nickel from 2001 to 2007.

``China is the big swing factor for commodities,'' said Gisjbert Groenewegen, a fund manager at Gold Arrow Capital Management in New York. ``It's an extremely important market for commodities because it's been the source of so much demand.''

Bolstering Sentiment

Even an economy the size of China's may not have the wherewithal to withstand the worst economic crisis since the Great Depression, said Ben Simpfendorfer, an economist at Royal Bank of Scotland Group.

``There is still a risk that an increasingly market-driven economy corrects faster than the fiscal package can be implemented,'' Simpfendorfer said. ``We need to see evidence in the coming months that the fiscal package is either spurring demand or bolstering sentiment.''

Marc Chandler, global head of currency strategy at Brown Brothers Harriman & Co. in New York estimates that only about a quarter of the package, or $150 billion, represents new spending. ``One implication of our point -- that the 4 trillion yuan announcement exaggerates the `newness' and size -- means that it should not be surprising if China announces additional fiscal stimulative measures next year.''

Still, yesterday's financial markets were reflecting the growing economic power of China and its 1.3 billion people. China passed Canada to become the largest source of imports into the U.S. last year, and since it joined the World Trade Organization in 2001, it has been the fastest growing major export market for American products, according to U.S. government data.

Record Trade Surplus

China's exports have quadrupled in seven years and its trade surplus reached a record $262 billion last year. China is the world's second-largest exporter behind Germany, the WTO says. The country has averaged 9.9 percent growth for the past 30 years and its expansion underpins demand for the exports of its Asian neighbors and commodities from iron ore to soybeans.

China contributed the most to global growth in 2007, 27 percent, the International Monetary Fund said in a report in April. The lender used purchasing power parity calculations, which account for differences in the currency exchange rates.

``If it had to, the government could easily afford to spend an extra 4 trillion to achieve'' the 8 percent economic growth it deems is necessary to prevent the jobless rate rising, said Mark Williams, an economist at Capital Economics in London. ``However, it is hoping that the signal it is giving with the announcement of this package will, in itself, be enough to catalyze a revival in confidence and stronger private sector spending.''

To contact the reporter on this story: David Tweed in Tokyo at dtweed@bloomberg.net