China’s period of five consecutive years of 10%-plus GDP growth is over

As chief economist for non-Japan Asia at Credit Suisse First Boston in Hong Kong and a former senior regional economist and head of China research at Schroders Securities Asia, Dong Tao is probably one of the most distinguished regional economists around.

So when he writes a summary of his fact-finding trips to the mainland from his perch in Hong Kong, China watchers usually sit up and take notice.

In his most recent report, while he cautions his readers not to “panic” about China’s slowing economy and writes that it is “unlikely” that GDP growth will fall much below 6%, the news isn’t exactly good either especially for global commodity markets.

On Nov. 3, Tao revised his China growth estimates for 2008 to 8.7% from 9.3% and to 7.2% from 8.8% for 2009 and says he “does not anticipate a strong rebound in growth in 2010 either.” Over the last 30 years, China has posted an average annual growth rate of 9.9%.

In the fourth quarter of this year, he predicts growth will slow to 5.8%, with 6% in the first quarter of 2009 and 6.3% in the second quarter. Growth in China has never fallen below 7% for more than two quarters since 1990, Tao points out.

“In our view this round of five consecutive years of 10%-plus GDP growth, driven by ‘super factors’ like WTO and the housing boom, is over,” he states. “We expect three to five years of sub-trend growth, until the next ‘super factor,’ possibly rural consumption, starts to emerge.”

Tao also believes that China will “slip into deflation” next year and that the Chinese currency, the renminbi or RMB, could see a minor depreciation against the U.S. dollar.

In Oct., the Purchasing Manager Index, one of the indicators that economists use to predict the direction of the Chinese economy, dropped to “an unprecedented” 44.6 “by far the worst number throughout the history of the data series,” which began in the first quarter of 2006.

The headline PMI for Oct. was down 6.6 percentage points from September and the new orders index fell 9.6 percentage points to 41.7 during the same period. New export orders fell 7.4 percentage points to 41.4. The import index also fell by 7 percentage points to 39.4.

The numbers demonstrate among other things weakening investment confidence in the private sector, eroding consumer sentiment and that export companies are “struggling with new orders and funding,” Tao writes.

“This set of PMI data is consistent with GDP growth at a pace of 5.5-6.5%, “far below the 8% level many observers consider as the recession threshold,” he writes.

Anecdotal evidence also illustrates that China’s economy is starting to slow down. According to Tao, real estate transactions have “slowed sharply” since the fourth quarter of 2007, while construction activities “have collapsed as developers struggle with cash flows.”

As a result, sales of construction materials have contracted as have prices. Car sales are also declining, home appliances sales have been poor, and travel is “still at its weakest level for over a decade.”

In a survey of what listed companies think about the current financial crisis, Tao writes that 45% of those polled said they “could not tell when the turning point would come.”

“In our view, when businesses feel uncertain about the future, they cut investment,” Tao says. “During our recent trips to the eastern and southern regions of China, we found that many investment projects have been put on hold.”

Tao also believes that non-performing loans at China’s banks will rise “materially” over the next two years “as the economic downturn bites.”

Of course the good news about China is that its vice-like capital controls have prevented “a large part” of the global financial crisis “from spreading into the country.”

And China has many other things going in its favor that will help it weather the storm. With a huge domestic market, for example, 1.3 billion people still generate significant demand for products including food and clothing.

Secondly, Chinese banks, unlike many of their counterparts in the West, have healthy balance sheets. “Capital control has saved China again,” he writes, and this means that “the severe credit crunch observed in many parts of the world may not happen in China.”

Moreover, China is underleveraged, he argues, and excess liquidity and robust capital markets have meant that corporates there have a lower debt ratio. Consumer debt is also low, he notes.

Finally, China’s powerful central government can switch to an expansionary fiscal and monetary policy at will, and in Tao’s view, will certainly do so. He forecasts that Beijing will authorize massive spending in railway infrastructure and the construction of subsidized housing for low-income families.

He also argues that central authorities are likely to spend huge amounts on healthcare reform and build thousands of kilometers of canals to transfer water from the Yangtze River to northern China.

If China moves ahead with aggressive financial and monetary policies, Tao predicts China’s growth could stabilize at around 8% over the next three years.

“That figure is low by China’s standards but a very decent number in view of the global recession,” Tao concludes. “But will the Chinese economy and domestic demand rebound strongly after that? The answer is probably not, in our view.”