China Economy: Summer Stock-Take and Forward Look
British Embassy Beijing
Growth has slowed faster than expected, concerns about credit have risen and the validity of Chinese data has been called further into question. But there is confidence that China’s new leadership will do what is necessary to deliver sustainable growth in the medium term. More public statements and a raft of new policies likely to be announced at 3rd Plenum meetings in the Autumn and hopes that implementation will start soon after. Expect the UK to continue to benefit.
The past year has been mixed. Most obviously, growth has slowed faster than expected…
The consensus forecast for 2013 has been lowered steadily to 7.5 percent, and many are now forecasting growth of around 7.3 percent in 2014. This is below the projection at the start of the year that the economy would continue to grow at roughly 8 percent for the next couple of years.
This slowdown has a number of causes. The growth impact of additional investment is falling, increasing the urgency of China’s transition away from investment dominated growth. At the same time, the economy appears to be entering a cyclical downturn and external demand remains sluggish.
…alongside this, credit levels have continued to rise…
The mini-stimulus launched last year was not on the scale of the 2008 intervention but it did entail a further expansion of credit, which reached 200 percent of GDP this year, up from 130 percent in 2008. It was also accompanied by the expansion of non-traditional forms of financial intermediation (referred to as ‘shadow-finance’), some of which lack clear regulatory oversight.
China’s credit levels are now unusually high for a developing economy, though still compare favourably with advanced economies (for example last year Mckinsey published a study showing overall credit in South Korea was around 300 percent of GDP, and in the UK was over 400 percent of GDP). The recent spike in credit failed to deliver much of an economic boost, which suggests the marginal growth impact of credit is falling rapidly.
That said, organisations like the IMF and OECD consider that the situation remains under control, provided future credit growth slows and measures are taken to improve the regulation of shadow finance.
…and long-standing concerns about data and transparency have been reinforced.
The reliability of some Chinese official data has long been debated. This year further data series have come under suspicion, including:
consumption data, which is widely regarded as understating the true position;
trade data, where widespread concerns about fraudulent invoicing compelled the authorities to completely revise their methodology; and
the official purchasing managers’ index, where subcomponents were absent from some of the more recent releases.
Poor public communication has exacerbated the situation, fuelling speculation about manipulation of the figures.
Despite all this, most analysts believe that the official data still provide the best indication of how the economy is doing, and that they compare reasonably favourably to official data from other countries at China’s stage of development.
Developments in the political economy have been more encouraging…
China’s new top leadership appear to have recognised the need to push forward with a new wave of economic and social reform. Premier Li, Finance Minister Lou and Governor Zhou have re-emphasised the importance of structural reform over particular growth figures.
There appears to be a strong consensus in the senior leadership and among the wider public in favour of faster, deeper reform.
…and this has been supported by some modest policy action, alongside some modest structural improvements.
A limited number of new economic policies introduced over the past year have (on the whole) supported the medium term rebalancing agenda. Most recently, policy-induced tightening of the inter-bank lending market clearly signals the end of unrestrained credit growth. Elsewhere, RMB appreciation has accelerated significantly. Some central government approvals have been abolished, representing the start of Li’s ambitious plan to remove ‘more than a third’ of such approvals. A VAT reform pilot has been rapidly expanded to support service sector development. Most recently, there has been a little progress in liberalising interest rates.
These changes have been accompanied by modest structural improvements to China’s economy. The most important has probably been rapid growth in the services sector, presumably driven by rising domestic consumption. This has been critical to labour market stability and income growth.
Looking ahead, we recognise the risks but remain optimistic…
There is little risk of China experiencing a hard landing (i.e. a very sudden deceleration in growth), based on three factors:
the robust short-term foundations of Chinese growth. Elevated investment levels cannot be sustained indefinitely but they can continue for the next few years. The process of substituting consumption for investment needs to accelerate, as illustrated by this year’s faster than expected slow-down, but strong service sector development and a stable labour market suggests that things are moving in the right direction;
China’s repressed financial system makes a conventional financial crisis unlikely. A run on the banks is unlikely, given they are owned by the government. State control means a system liquidity crisis is inconceivable. There is very little foreign debt that could be recalled. The government has in the past shown willingness to intervene decisively to stop financial problems from contaminating the rest of the economy; and
the authorities can still respond with either monetary or fiscal policy, if serious difficulties emerge. Total central and local government debt (including off-balancing sheet lending) is estimated at about 50 percent GDP. This is still manageable, particularly given the Chinese government’s extensive assets. There is also space for monetary easing.
…but we should expect future growth to be bumpy and continue to trend downward.
The challenge the authorities face is how to preserve stability (by which we mean stable inflation and low unemployment) while the economy restructures. It is much easier for the authorities themselves to adjust investment than consumption. Therefore, as China’s economy becomes more reliant on consumption as the driver of growth it is inevitable that the future growth trajectory will be more bumpy than its past. In effect, China will become a more ‘normal’ economy, subject to greater cyclical fluctuations.
The more progress is made with economic reform, the slower and more volatile near-term growth will be. Even though they are essential for economic sustainability, things like financial sector liberalisation are likely to reduce China’s short-term growth potential. Decision-making processes, and the public communication of those decisions, will need to become more open to avoid giving rise to rumours and speculation and adding to volatility in the markets.
Reforms will not be easy to implement…
The broad substance around China’s future reform package is now very familiar. The financial system needs to be liberalised to ensure capital is allocated more efficiently. The provision of social services needs to be reformed, particularly for internal migrants, to support consumption. The internal market for goods and services needs to be liberalised to ensure future productivity gains and job creation.
Each of these areas is complex and multi-faceted, but they are often bound together by Premier Li into a single narrative of ‘urbanisation’. What this essentially means is supporting private sector development by changing the Government’s role away from direct control and towards the regulation of markets and the provision of genuine public goods. This is what makes the switch in rhetorical focus from growth to employment so significant: while headline growth can be driven by the state sector, employment generation in China today comes only from the private sector.
The implications of these changes are immense. Premier Li talks of a self-imposed revolution. The reforms he is promoting create obvious losers and implementation of the reforms will require a huge degree of coordination across central government departments and between central and local governments.
…but, on balance, there is confidence that obstacles to reform will be surmounted…
It’s worth remembering that, over the past 30 years, the Chinese economy has successfully implemented hugely disruptive episodes of reform. As the IMF said at the recent Article IV Press Conference, “this success in [these] previous episodes of reform reflects the government’s ability to implement reforms, often very difficult ones, and this does provide confidence that China has the ability to tackle its current economic challenges, even if these are formidable”.
We will find out more about the authorities’ specific priorities for reform at the Communist Party’s Third Plenum. We should expect more encouraging rhetoric, backed by some degree of prioritisation. But as President Xi is fond of saying ‘empty talk is meaningless, national salvation comes only through implementation’.
…and that the UK will continue to benefit.
Since at least 2011, the view has been that the UK should disproportionately benefit as the Chinese economy matures, moves up the value chain and increases consumption. This has certainly been the case recently. In the context of declining Chinese growth, direct benefits to the UK, in the form of exports to China and investment and visitors from China, have increased significantly. These positive trends should continue in the years ahead.
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