China's stimulus working – perhaps too well

Bank loans and state-led investment have reenergized the economy, and people feel more secure about their jobs. But the government has boosted spending so fast that economists are warning of stock and real-estate bubbles.

Late last year, as a global recession snapped at China's heels, Tomer Rothschild's sales team began to sweat. Selling gym membership to white-collar workers had suddenly gotten harder.

Today, the treadmills are humming again. "Back then, people were worried about their jobs. There's much less of that now," says Mr. Rothschild, CEO of Ozone Fitness, which owns 10 clubs in Beijing.

As goes the fitness boom in Beijing, so goes China's economy. While Washington argues over the impact of its stimulus package, China's government has ramped up spending so rapidly this year that economists are warning of stock and real-estate bubbles. Beijing argues that supporting the recovery remains its priority.

One reason for caution is that China's exports continue to slide. Data released Tuesday showed that exports in July fell 23 percent year-on-year, the ninth straight month of decline.

But on the back of record bank lending and state-led investment, China's economy is accelerating: It grew by 8 percent in the second quarter, snapping a period of slowdown.

What recession? Malls, restaurants are packed.

Far from being felled by the global slump, many Chinese consumers believe that the good times are still rolling. Nearly 5.4 million cars were sold in the year to July 31, up 30 percent over last year. Leisure travel – seen as a luxury only a few years ago – is growing rapidly. Many restaurants and malls in Beijing are packed.

More robust Chinese spending holds out promise for other struggling economies. Domestic consumption has long lagged in China, where households save much of their income and the government runs huge trade surpluses that are ploughed into foreign-currency reserves, mostly US government debt.

"It's not the big adjustment we'd all like to see in China away from investment and towards consumption. But if you have relatively strong [economic] growth, you still end up with strong consumer growth," says Michael Buchanan, an economist for Goldman Sachs in Hong Kong.

Economists say it's unwise to expect Chinese consumers to pick up the slack from debt-saddled Americans, as growth is still driven largely by state-led investment. But open Chinese wallets point to an eventual rebalancing of trade flows, so that Asian countries consume more of what they produce.

Massive spending on infrastructure

China's stimulus has soaked up demand for industrial output, giving relief to sectors hit by slowing exports. Huge spending on infrastructure projects like roads and public works have jolted the economy.

The downside, however, is that heavy industries like steel aren't rationalizing, says Arthur Kroeber, managing director of Dragonomics, an economic consultancy in Beijing. "The risk is that producers will expand capacity," he says.

One contentious trade issue is China's currency, which the US Congress has criticized as undervalued. A stronger currency would increase the purchasing power of Chinese consumers and discourage excessive investment. But the Obama administration has not pushed publicly for revaluation, which is strongly resisted by China.

Fuzzy statistics

Gauging the extent of China's recovery is complicated by the reliability of its data. Some state-owned media have ridiculed National Bureau of Statistic (NBS) figures, particularly on incomes. Analysts say aggregate national data doesn't always match that reported by individual provinces, where much of the stimulus spending is concentrated.

"As long as [the NBS] is part of the government, they have to listen to their bosses," says Xu Xiaonian, a professor at the China-Europe International Business School in Shanghai, who favors an independent bureau.

Mr. Xu and others warn that China's economy is fragile, as private investment remains tepid. As a result, growth may falter, even as the US begins to pull itself up. "I'm feeling less and less confident about China's recovery," he says.

'Excellent' job prospects

Others feel differently. In a survey taken in June, Nielson found that confidence was rising in urban China, as it was elsewhere in Asia.

The key driver in China was job security: More than half of the 3,500 people surveyed said their job prospects would be good or excellent over the next 12 months. In March, only 22 percent of respondents felt that way.

That optimism matters to Beijing's private gyms, which have mushroomed as more Chinese pay attention to fitness and health. In 2001, the city had only five gyms, excluding luxury hotels. Now there are about 400, says Rothschild.

The pace of new openings has slowed. But the blame doesn't lie primarily with the economy, says Liu Gang, CEO of O.E. Gymnasium Club. The industry resorted to cutthroat pricing and turned off consumers with poor service.

"So many gyms have closed in Beijing because the management didn't do a good job," he says.

Back in 2004, when Mr. Liu opened his first club, it was different. "As long as you opened the door, you could earn money," he says.

Then in 2007, a rival chain in Beijing began a price war. Annual dues dropped below $100, down from more than $400, says Ding Bo, a branch manager. Consumers shopped around for deals. "Lots of people think gyms are an easy business to run. Lots of people want to invest. It's chaos," he says.

Rothschild says the price war is a symptom of the gym industry's focus on chasing new members, rather than hanging onto existing ones. As a result, only 15 percent of members chose to renew, compared to 60 percent in the US.

Gyms are feeling the pinch more in Guangzhou, the southern city where fortunes are tied closely to exports, says Liu, who operates two clubs there. He has put expansion plans on hold.

Beijing is protected from the storm by its employment profile, making it an imperfect yardstick for economic resilience. Young professionals who work out in private gyms here are more likely to work for the government or state companies. "We're in a self-contained economic sphere in Beijing," says Rothschild.