Op-Ed Contributors

Will asset bubble go the Japan way?

By Syetarn Hansakul (China Daily)
Updated: 2010-05-11 07:53

Striking parallels between China today and Japan in the late 1980s suggest China faces similar risk as Japan did then. The risk of a sharp correction in China's asset markets when the economy slows down should not be overlooked, though it would not necessarily lead to a prolonged and deep economic recession as it did in Japan in the 1990s.

Bank loans are/were growing faster than nominal GDP growth in both the countries. In addition, lending decisions are/were not always based on creditworthiness. Although in the past there have been efforts in China to reduce State-directed bank lending, events in 2009 showed that State moral suasion remains influential in banks' lending decision. As in China today, strong loan growth to the real estate and construction sectors was observed in Japan in the late 1980s.

China's Shanghai A shares were trading 25 times and Shenzhen A shares 45 times their price/earnings (P/E) at the end of last month. The P/E of Japanese equities in 1990 was 50 times. In comparison, the S&P 500 P/E is currently about 17.5 times. Also, Japan's real estate prices rose 150 percent between mid-1986 and mid-1991. Prices of second-hand house prices in Shanghai rose by about 70 percent in 2004-09.

The excessive fixed investment rate is the result of heavy lending and high asset prices. The share of investment to GDP in Japan was 31 percent in 1988-1990. It is about 41 percent in China today.

But there are differences between Japan of the late 1980s and today's China. China is a much larger country in terms of territory and population, and more importantly, it has higher long-term GDP growth potential. The Chinese economy remains largely protected from sharp swings in portfolio investments, which reduces the risk of volatility from global financial markets.

Although the Japanese collapse in demand was largely a domestic problem, triggered by a domestic factor (as opposed to the 1997 Asian financial crisis, which was triggered by outflows of foreign hot money), the relatively sheltered nature of the Chinese economy makes it easier for Beijing to influence domestic market psychology. Moreover, Beijing has capital controls while Tokyo did not.

Greater disparity in China's urban-rural divide gives room for reallocation of resources. This gives the Chinese government more scope to make GDP growth smooth, i.e. steer resources away from the overheated sectors/areas to deficit sectors/areas, thus potentially reducing the risk of a hard landing.

Large foreign direct investment (FDI) and joint ventures (JV) in China mitigate risks. China has absorbed massive FDI inflows (a rough estimate of cumulative utilized FDI since 1992 would be $1 trillion), thus foreign direct investors & JV partners are big stakeholders in the Chinese economy, mitigating the risk that they would desert the country easily during a downturn. Besides, Japan's manufacturing sector was much more closed compared with China's today.

A valuable lesson learned from Japan is that imbalances cannot be corrected through macroeconomic measures alone. They have to be accompanied by microeconomic reforms. The fact that microeconomic reforms are being implemented in China for some time now gives the country a chance to avoid a Japan-style downturn.